                               T.C. Memo. 2012-148



                         UNITED STATES TAX COURT



                   BARBARA K. WEST, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 9498-09.1                            Filed May 24, 2012.



      Barbara K. West, pro se.

      Anne M. Craig, for respondent.




      1
        The Court initially granted petitioner’s request that the case be conducted as
a small tax case. At the commencement of trial the Court noted that the deficiency
including the addition to tax and penalty for 2006 exceeded $50,000. As a result the
Court concluded that the case did not qualify for small tax case treatment. See sec.
7463(a), (e). The Court directed that the small tax case designation be removed and
that the proceeding not be conducted under small tax case procedures. See Rule
171(c). Unless otherwise indicated, all section references are to the Internal
Revenue Code (Code) in effect at all relevant times, and all Rule references are to
the Tax Court Rules of Practice and Procedure.
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              MEMORANDUM FINDINGS OF FACT AND OPINION


       THORNTON, Judge: Pursuant to section 7443A and Rules 180 and 183, this

case was assigned to and heard by Chief Special Trial Judge Peter J. Panuthos. His

recommended findings of fact and conclusions of law were filed and served upon

the parties on November 16, 2011. Petitioner and respondent filed no objection to

the Chief Special Trial Judge’s recommended findings of fact and conclusions of

law.

       After reviewing the record in this case and the report of the Chief Special

Trial Judge, we adopt the recommended findings of fact and conclusions of law of

Chief Special Trial Judge Panuthos as the report of the Court.

       Respondent determined deficiencies, additions to tax, and penalties for

petitioner’s 2005, 2006, and 2007 Federal income tax in the following amounts:

                                        Addition to tax       Penalty
       Year         Deficiency          Sec. 6651(a)(1)     Sec. 6662(a)

       2005             $630                 $100.00              --
       2006           35,463                8,858.25          $7,092.60
       2007           12,714                3,178.50           2,542.80

       The issues for decision are: (1) whether petitioner received unreported

income for 2005, 2006, and 2007; (2) whether petitioner is entitled to business

expense deductions in excess of those respondent allowed for 2006 and 2007;
                                         -3-

(3) whether petitioner is liable for a section 6651(a)(1) addition to tax for 2005,

2006, and 2007; and (4) whether petitioner is liable for a section 6662(a) penalty for

2006 and 2007.

                                FINDINGS OF FACT

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

facts, the supplemental stipulation of facts, and the attached exhibits are

incorporated herein by this reference. Petitioner resided in Florida when she filed

her petition.

       Petitioner moved to Florida from Colorado in 1998. In December 2005 she

opened Alex’s Family Restaurant and operated it as a sole proprietorship throughout

2006 and 2007. Petitioner owned and operated Sea Breeze Restaurant as a sole

proprietorship from March through October 2006. She also operated and was the

sole shareholder of Jasmine West, LLC, during 2006 and through June 2007.

Petitioner maintained a bank account for each business as well as multiple personal

bank accounts.2 She employed a bookkeeper in 2006 for her businesses but did not




       2
       The record reflects that petitioner maintained one bank account for Alex’s
Family Restaurant, one for Sea Breeze Restaurant, one for Jasmine West, LLC,
under the name of “Barbara West D/B/A Zorba’s”, and two personal bank accounts.
                                         -4-

otherwise maintain books for the businesses.3 She often borrowed funds from one

business to pay the expenses of another business. Petitioner’s other sources of

funds for the businesses included proceeds from the sale of real estate and personal

loans from friends.

      Petitioner did not timely file her Federal income tax return for 2005, 2006, or

2007. A representative of the Internal Revenue Service (IRS) contacted petitioner

in 2008 and informed her of her filing requirement. Petitioner thereafter filed

delinquent returns.4

      The IRS requested petitioner’s business records to verify her income. She

provided to the IRS check registers for some of the bank accounts and some bank

records. The IRS thereafter requested from the bank petitioner’s complete bank

records. The IRS reviewed petitioner’s business and personal bank accounts and

performed a bank deposits analysis. The IRS examiner discussed the various entries

      3
        The record does not reflect the scope of the bookkeeper’s responsibilities.
Petitioner did not provide any books or records at trial.
      4
        Petitioner filed a 2005 Form 1040EZ, Income Tax Return for Single and
Joint Filers With No Dependents, and a 2007 Form 1040, U.S. Individual Income
Tax Return, on June 13, 2008. Petitioner also filed a 2006 Form 1040 on August
28, 2008, and a 2006 Form 1120S, U.S. Income Tax Return for an S Corporation,
on August 29, 2008. It appears petitioner also submitted at least one amended
return to the IRS examiner. The 2005 return attached as an exhibit to the
stipulations does not include a Schedule C, Profit or Loss From Business, or any
business income.
                                          -5-

with petitioner and accepted her characterization of many of the deposits she could

identify. Petitioner failed to provide complete records to substantiate business

expenses or nontaxable items and was unable to identify all of the deposits listed in

the bank records.

      On March 3, 2009, respondent issued to petitioner a notice of deficiency for

2005, 2006, and 2007. Using a bank deposits analysis, respondent determined that

petitioner had omitted income as follows:

                                2005                 2006                2007

 Total deposits             $244,564.54          $265,311.95          $146,171.64
 Nontaxable items            (119,490.00)          (40,275.49)          (11,347.62)
 Net deposits
  (gross receipts)           125,074.54           225,036.46           134,824.02
 Amounts reported
  as gross receipts          113,482.53            73,909.00            85,222.00
 Adjustment                   11,592.01           151,127.46            49,602.02

Respondent also determined an addition to tax for delinquent filing of returns and a

negligence penalty. On April 20, 2009, petitioner filed a petition disputing the

determinations in the notice of deficiency.

                                       OPINION

I. Unreported Income

      In general, the Commissioner’s determination set forth in a notice of

deficiency is presumed correct, and the taxpayer bears the burden of showing that
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the determination is in error. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

(1933). Pursuant to section 7491(a), the burden of proof as to factual matters

shifts to the Commissioner under certain circumstances. Petitioner has neither

alleged that section 7491(a) applies nor established her compliance with the

substantiation and recordkeeping requirements. See sec. 7491(a)(2)(A) and (B).

Therefore, the burden of proof remains on petitioner to show that the deposits are

not taxable income. See Rule 142(a); Dodge v. Commissioner, 96 T.C. 172, 181

(1991), aff’d in part, rev’d in part and remanded on other grounds, 981 F.2d 350

(8th Cir. 1992); Reaves v. Commissioner, 31 T.C. 690, 718 (1958), aff’d, 295 F.2d

336 (5th Cir. 1961).

      Taxpayers are required to maintain adequate books and records which

reflect income in order to substantiate claimed tax deductions and to produce those

records to the IRS when requested. Sec. 6001; sec. 1.6001-1(a), (e), Income Tax

Regs. When a taxpayer fails to keep adequate books and records, the

Commissioner is authorized to determine the existence and amount of the

taxpayer’s income by any method that clearly reflects income. See sec. 446(b);

Petzoldt v. Commissioner, 92 T.C. 661, 693 (1989). The Commissioner may use

indirect methods, and he is given latitude in determining which method of

reconstruction to apply. Id. The Commissioner’s reconstruction of a taxpayer’s
                                         -7-

income need only be reasonable in the light of all surrounding facts and

circumstances. Schroeder v. Commissioner, 40 T.C. 30, 33 (1963); see also Giddio

v. Commissioner, 54 T.C. 1530, 1533 (1970).

      One of the indirect methods of reconstructing income is the bank deposits

method. “The use of the bank deposit[s] method for computing income has long

been sanctioned by the courts.” Estate of Mason v. Commissioner, 64 T.C. 651,

656 (1975), aff’d, 566 F.2d 2 (6th Cir. 1977); see also United States v. Innes, 270

Fed. Appx. 899, 903 (11th Cir. 2008); United States v. Boulet, 577 F.2d 1165, 1171

(5th Cir. 1978). Bank deposits constitute prima facie evidence of income. Tokarski

v. Commissioner, 87 T.C. 74, 77 (1986); see also Clayton v. Commissioner, 102

T.C. 632, 645 (1994). When a taxpayer’s books or records are inadequate or

incomplete and the taxpayer has large bank deposits, the Commissioner is not acting

arbitrarily or capriciously by resorting to the bank deposits method to reconstruct

income. See DiLeo v. Commissioner, 96 T.C. 858, 867-868 (1991), aff’d, 959 F.2d

16 (2d Cir. 1992).

      The bank deposits method of reconstruction assumes that all of the deposits

into a taxpayer’s account are taxable income unless the taxpayer can show that the

deposits are not taxable. Id. at 868-869. The Commissioner need not show a likely

source of the income when using the bank deposits method, but he must take into
                                          -8-

account any nontaxable items or deductible expenses of which he has knowledge.

See Price v. United States, 335 F.2d 671, 677 (5th Cir. 1964); see also DiLeo v.

Commissioner, 96 T.C. at 868.

      The record reflects that petitioner conducted more than one business activity

during the years in issue. The record also reflects that petitioner either failed to

keep adequate books and records or failed to provide them during the examination

of her returns. As a result, respondent used the bank deposits method to determine

gross receipts and business expenses.

      During the examination and reconstruction petitioner met with the IRS

examiner to identify various deposits and their nature as loans, proceeds from sale

of real estate, and other items. Although the examiner accepted the

characterizations of many entries in the bank records as petitioner proposed,

petitioner was unable to identify all of the deposits. As a result, the examiner

concluded that petitioner neither included all of the gross receipts on her returns nor

substantiated all of her claimed business expenses for 2005, 2006, and 2007.

      At trial petitioner did not assert that any of the deposits characterized as

income were nontaxable items. She presented some very generalized testimony that

her businesses did not make money. She did not provide any documents to the

Court to support a finding that any of the deposits were nontaxable items.
                                          -9-

Therefore, we find that petitioner had unreported income for 2005, 2006, and 2007

in the amounts respondent determined.

II. Schedule C Deductions

      Deductions are a matter of legislative grace. Deputy v. du Pont, 308 U.S.

488, 493 (1940); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). A

taxpayer bears the burden of proving entitlement to any deduction claimed. Rule

142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); Welch v.

Helvering, 290 U.S. 111, 115 (1933); Wilson v. Commissioner, T.C. Memo. 2001-

139. The fact that a taxpayer reports a deduction on the taxpayer’s income tax

return is not sufficient to substantiate the claimed deduction. Wilkinson v.

Commissioner, 71 T.C. 633, 639 (1979); Roberts v. Commissioner, 62 T.C. 834,

837 (1974). Rather, an income tax return is merely a statement of the taxpayer’s

claim; it is not presumed to be correct. Wilkinson v. Commissioner, 71 T.C. at 639;

Roberts v. Commissioner, 62 T.C. at 837; see also Seaboard Commercial Corp. v.

Commissioner, 28 T.C. 1034, 1051 (1957) (a taxpayer’s income tax return is a self-

serving declaration that may not be accepted as proof for the claimed deduction or

exclusion); Halle v. Commissioner, 7 T.C. 245, 245-250 (1946) (a taxpayer’s

income tax return is not self-proving as to the truth of its contents), aff’d, 175 F.2d

500 (2d Cir. 1949). A taxpayer must substantiate amounts claimed as deductions by
                                         - 10 -

maintaining the records necessary to establish that he or she is entitled to the

deductions. Sec. 6001.

      Section 162(a) provides a deduction for certain business-related expenses. In

order to qualify for the deduction under section 162(a), “an item must (1) be ‘paid

or incurred during the taxable year,’ (2) be for ‘carrying on any trade or business,’

(3) be an ‘expense,’ (4) be a ‘necessary’ expense, and (5) be an ‘ordinary’

expense.” Commissioner v. Lincoln Sav. & Loan Ass’n, 403 U.S. 345, 352 (1971);

Deputy v. du Pont, 308 U.S. at 495 (to qualify as “ordinary”, the expense must

relate to a transaction “of common or frequent occurrence in the type of business

involved”). Whether an expense is ordinary is determined by time, place, and

circumstance. Welch v. Helvering, 290 U.S. at 113-114.

      A review of this record was made exceedingly difficult as the tax return

information did not align with the adjustments in the notice of deficiency. Although

respondent apparently allowed some Schedule C business expense deductions and

disallowed others, the notice of deficiency did not clearly identify these items, nor

did respondent offer a clear explanation in his trial memorandum or at trial. On the

other hand, petitioner failed to present any documentary evidence or testimony that

would suggest that she is entitled to additional Schedule C business expense

deductions. The record reflects that petitioner owned and operated several
                                         - 11 -

businesses during the years in issue and likely incurred business expenses.

However, petitioner relies on her very general statement that she did not

make a large profit. Without evidence of the nature or amounts of expenses, we

have no basis upon which to allow additional Schedule C business expense

deductions.

III. Failure To File

      Section 6651(a)(1) imposes an addition to tax for failure to file a return on the

date prescribed (including extensions) unless the taxpayer can establish that the

failure is due to reasonable cause and not due to willful neglect.

      Respondent has satisfied his burden of production under section 7491(c) by

establishing, as petitioner acknowledges, that petitioner did not file her 2005, 2006,

and 2007 Federal income tax returns by their due dates. Therefore, petitioner bears

the burden of proving that her failure to file the returns was due to reasonable cause

and not due to willful neglect. See Higbee v. Commissioner, 116 T.C. 438, 447

(2001); Ruggeri v. Commissioner, T.C. Memo. 2008-300.

      Reasonable cause is a defense to the section 6651(a)(1) addition to tax. To

prove reasonable cause for a failure to timely file, the taxpayer must show that she

exercised ordinary business care and prudence and was nevertheless unable to file
                                          - 12 -

the return within the prescribed time. Crocker v. Commissioner, 92 T.C. 899, 913

(1989); sec. 301.6651-1(c)(1), Proced. & Admin. Regs. The determination of

whether reasonable cause exists is based on all the facts and circumstances. Estate

of DiRezza v. Commissioner, 78 T.C. 19, 33 (1982); Estate of Hartsell v.

Commissioner, T.C. Memo. 2004-211; Merriam v. Commissioner, T.C. Memo.

1995-432, aff’d without published opinion, 107 F.3d 877 (9th Cir. 1997).

       Petitioner alleges that she did not file her returns because she believed she did

not make enough combined profit in her businesses to be required to file a return.

When the IRS contacted petitioner in 2008, the agent informed her that she was

required to file tax returns. Petitioner thereafter hired a return preparer and filed

delinquent returns for 2005, 2006, and 2007. Petitioner gave no other reason for her

failure to file the 2005, 2006, and 2007 returns. Petitioner’s mistaken belief does

not constitute reasonable cause for failure to timely file her returns. See Henningsen

v. Commissioner, 26 T.C. 528, 536 (1956) (“there is no showing that advice of

counsel was in fact sought or relied upon. Mere uninformed and unsupported belief

by a taxpayer, no matter how sincere that belief may be, that he is not required to

file a tax return, is insufficient to constitute reasonable cause for his failure so to

file.”), aff’d, 243 F.2d 954 (4th Cir. 1957); see also Soltan v. Commissioner, T.C.

Memo. 2010-91.
                                         - 13 -

      We conclude that petitioner has not shown her failure to timely file returns

was due to reasonable cause. Therefore, we find that petitioner is liable for the

section 6651(a)(1) addition to tax for 2005, 2006, and 2007.

IV. Accuracy-Related Penalty

      Taxpayers may be liable for a 20% penalty on the portion of an underpayment

of tax attributable to negligence, disregard of rules or regulations, or a substantial

understatement of income tax. Sec. 6662(a) and (b)(1) and (2).

      The term “negligence” in section 6662(b)(1) includes any failure to make a

reasonable attempt to comply with the Code, and the term “disregard” includes any

careless, reckless, or intentional disregard. Sec. 6662(c). Negligence has also been

defined as the failure to exercise due care or the failure to do what a reasonable

person would do under the circumstances. See Allen v. Commissioner, 92 T.C. 1,

12 (1989), aff’d, 925 F.2d 348 (9th Cir. 1991); Neely v. Commissioner, 85 T.C.

934, 947 (1985). Negligence also includes any failure by the taxpayer to keep

adequate books and records or to substantiate items properly. Sec. 1.6662-3(b)(1),

Income Tax Regs. An “understatement of income tax” is substantial if it exceeds

the greater of 10% of the tax required to be shown on the return or $5,000. Sec.

6662(d)(1)(A).
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      A taxpayer may avoid the application of an accuracy-related penalty by

proving she acted with reasonable cause and in good faith. See sec. 6664(c)(1); see

also Higbee v. Commissioner, 116 T.C. at 446-448; sec. 1.6664-4(a), Income Tax

Regs. We analyze whether a taxpayer acted with reasonable cause and in good faith

by examining the relevant facts and circumstances and, most importantly, the extent

to which the taxpayer attempted to assess her proper tax liability. See Neely v.

Commissioner, 85 T.C. at 947; Stubblefield v. Commissioner, T.C. Memo. 1996-

537; sec. 1.6664-4(b)(1), Income Tax Regs. In order for the reasonable cause

exception to apply, the taxpayer must prove that she exercised ordinary business

care and prudence as to the disputed items. Neonatology Assocs., P.A. v.

Commissioner, 115 T.C. 43, 98 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002).

      Respondent has met his burden of production under section 7491(c) for the

accuracy-related penalty for negligence by showing that petitioner omitted gross

receipts and failed to maintain adequate records. Petitioner provided no

documentation to the Court and made no attempt to prove the source or nature of

the unreported income or to substantiate various disallowed expenses. Petitioner

did not show that she made a reasonable attempt to comply with the Code or that
                                         - 15 -

she acted in good faith. She failed either to maintain or to produce books and

records with respect to her business activities.

      We conclude that petitioner is liable for the section 6662(a) accuracy-related

penalty for negligence for 2006 and 2007. Because we have found that petitioner is

liable for the accuracy-related penalty for negligence, we need not discuss whether

she had a substantial understatement of income tax.

      To reflect the foregoing,


                                                        Decision will be entered

                                                  for respondent.
