                              T.C. Memo. 2014-104



                         UNITED STATES TAX COURT



    GEORGE B. DOUGLAS, JR., AND PEARL J. DOUGLAS, Petitioners v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 5078-12.                          Filed May 29, 2014.



      George B. Douglas, Jr., and Pearl J. Douglas, pro sese.

      Nathan M. Swingley and Stewart Todd Hittinger, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


      CHIECHI, Judge: Respondent determined deficiencies in, and accuracy-

related penalties under section 6662(a)1 on, petitioners’ Federal income tax (tax)

as follows:


      1
       All section references are to the Internal Revenue Code (Code) in effect for
the years at issue. All Rule references are to the Tax Court Rules of Practice and
Procedure.
                                         -2-

[*2]

                                                          Accuracy-Related
                                                           Penalty Under
                 Year                 Deficiency            Sec. 6662(a)
                 2007                  $35,364                  $7,072.80
                 2008                    49,725                  9,945.00
                 2009                    25,847                  5,169.40

       The issues remaining for decision are:

       (1) Do petitioners have a loss that is attributable to Apple Pie Mortgage,

LLC, for each of their taxable years 2007, 2008, and 2009? We hold that they do

not.

       (2) Do petitioners have a loss that is attributable to Douglas & Jenkins, Inc.,

an S corporation, for each of their taxable years 2007, 2008, and 2009? We hold

that they do not.

       (3) Do petitioners have certain unreported income of $19,020, $42,111, and

$22,210 for their taxable years 2007, 2008, and 2009, respectively, that respondent

determined on the basis of the bank deposits method? We hold that they do.

       (4) Are petitioners entitled for their taxable year 2008 to the first-time

homebuyer credit under section 36(a)? We hold that they are not.
                                          -3-

[*3] (5) Are petitioners liable for each of their taxable years 2007, 2008, and

2009 for the accuracy-related penalty under section 6662(a)? We hold that they

are.

                                FINDINGS OF FACT

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

       Petitioners resided in Indiana at the time they filed the petition.

       On November 22, 1999, petitioner Pearl J. Douglas (Ms. Douglas) pur-

chased certain property (Pike Creek property) on Pike Creek Lane in Indianapolis,

moved into the house (Pike Creek house) on that property, and resided there until

around September 10, 2008.

       On April 14, 2002, Ms. Douglas executed a quitclaim deed in which she

quitclaimed her interest in the Pike Creek property to her minor children, RB and

JB, for “good consideration and for the sum of one Dollar[]”. For a period not

established by the record after Ms. Douglas executed the quitclaim deed, she con-

tinued to pay all of the expenses associated with the Pike Creek property, includ-

ing expenses for electricity, trash service, homeowners insurance, and real prop-

erty taxes.
                                         -4-

[*4] During the years at issue, petitioners maintained, and had signatory author-

ity over, certain bank accounts (petitioners’ bank accounts) at Energy Plus Credit

Union and JP Morgan Chase.

      During the years at issue, petitioner George B. Douglas, Jr. (Mr. Douglas)

worked for Citizens Gas & Coke Utility Trust (Citizens Gas). During those years,

Mr. Douglas received wage income from Citizens Gas of $52,652, $52,931, and

$54,629, respectively.

      During the years at issue, Mr. Douglas owned 50 percent of the stock of

Douglas & Jenkins, Inc. (Douglas & Jenkins), an S corporation, that operated a bar

and night club in Indianapolis under the name “Club Escalade”. During those

years, Club Escalade sold alcoholic beverages, nonalcoholic beverages, and food

that Douglas & Jenkins had purchased from certain vendors (Club Escalade ven-

dors). On May 9, 2009, Club Escalade was destroyed by a fire and ceased oper-

ating as a business.

      During the years at issue, Ms. Douglas was the sole member of Apple Pie

Mortgage, LLC (Apple Pie Mortgage), which operated a mortgage brokerage busi-

ness that obtained for its clients conventional loans from various financial institu-

tions as well as loans insured by the Federal Housing Administration (FHA) and

the U.S. Department of Veterans Affairs. During those years, the FHA required
                                       -5-

[*5] Apple Pie Mortgage to undergo annual independent audits. In order to satisfy

that requirement, Apple Pie Mortgage engaged Bauer & Bauer, LLC (Bauer &

Bauer), a certified public accounting firm, to perform an independent audit of

Apple Pie Mortgage for each of the years at issue. Upon completion of each of

those audits, Bauer & Bauer prepared an audit report (collectively, Apple Pie

Mortgage audit reports). The Apple Pie Mortgage audit reports showed that Apple

Pie Mortgage had (1) “Total Loan revenue” of $100,120, $119,072, and $93,799

and (2) “Total Operating expenses” of $76,930, $86,629, and $68,627 for its

taxable years 2007, 2008, and 2009, respectively.

      Around September 10, 2008, Mr. Douglas purchased certain property (Lone

Tree property) on Lone Tree Court in Indianapolis and moved with Ms. Douglas

into the house on that property.

      Douglas & Jenkins filed Form 1120S, U.S. Income Tax Return for an S

Corporation (Form 1120S), for each of its taxable years 2007 (2007 Form 1120S),

2008 (2008 Form 1120S), and 2009 (2009 Form 1120S). In the 2007 Form 1120S,

Douglas & Jenkins reported “Gross receipts or sales” of $70,200 and “Cost of

goods sold” of $56,307 and claimed “Total deductions” of $32,587 (2007 claimed

Form 1120S deductions) and “Ordinary business income (loss)” of negative

$18,694. The 2007 claimed Form 1120S deductions consisted of the following:
                                         -6-

[*6]

                       Deduction                  Amount
              Interest                             $4,687
              Depreciation not claimed
               on Schedule A or
               elsewhere on return                  8,959
              Accounting                              600
              Insurance                             3,492
              Laundry and cleaning                    183
              Security                                600
              Supplies                              1,459
              Telephone                             1,208
              Utilities                            10,877
              Trash service                           522
               Total                               32,587

       In the 2008 Form 1120S, Douglas & Jenkins reported “Gross receipts or

sales” of $91,308 and “Cost of goods sold” of $74,899 and claimed “Total deduc-

tions” of $28,539 (2008 claimed Form 1120S deductions) and “Ordinary business

income (loss)” of negative $12,130. The 2008 claimed Form 1120S deductions

consisted of the following:
                                         -7-

[*7]

                       Deduction                  Amount
              Depreciation not claimed
               on Schedule A or
               elsewhere on return                 $8,052
              Accounting                              600
              Insurance                             3,350
              Laundry and cleaning                    240
              Security                              1,391
              Telephone                             1,451
              Utilities                            12,167
              Trash service                         1,288
               Total                               28,539

       In the 2009 Form 1120S, Douglas & Jenkins reported “Gross receipts or

sales” of $31,997 and “Cost of goods sold” of $37,847 and claimed “Total deduc-

tions” of $14,756 (2009 claimed Form 1120S deductions) and “Ordinary business

income (loss)” of negative $20,606. The 2009 claimed Form 1120S deductions

consisted of the following:
                                         -8-

[*8]

                        Deduction                     Amount
              Depreciation not claimed
               on Schedule A or
               elsewhere on return                      $7,146
              Dues and subscriptions                       191
              Insurance                                  2,122
              Telephone                                    858
              Utilities                                  4,439
                Total                                   14,756

       Petitioners filed joint tax returns for their taxable years 2007 (2007 return),

2008 (2008 return), and 2009 (2009 return). In the 2007 return, petitioners

showed the address of the Pike Creek property as their home address. In that re-

turn, petitioners reported “Wages, salaries, tips, etc.” of $52,652, “Taxable inter-

est” of $1,075, “Business income or (loss)” of negative $36,231, and “total in-

come” of $17,496.

       In the 2008 return, petitioners reported “Wages, salaries, tips, etc.” of

$52,931, “Taxable interest” of $1,863, “Business income or (loss)” of negative

$34,737, “Other income” of $2,260, and “total income” of $16,192. In that return,

petitioners also claimed a first-time homebuyer credit of $7,500 with respect to the

Lone Tree property.
                                        -9-

[*9] In the 2009 return, petitioners reported “Wages, salaries, tips, etc.” of

$54,629, “Taxable interest” of $219, “Business income or (loss)” of negative

$33,387, and “total income” of negative $3,237.

      Petitioners included Schedule C, Profit or Loss From Business (Schedule

C), with respect to Mr. Douglas’ 50 percent ownership of Douglas & Jenkins

(Douglas & Jenkins Schedule C) with each of the 2007 return (2007 Douglas &

Jenkins Schedule C), the 2008 return (2008 Douglas & Jenkins Schedule C), and

the 2009 return (2009 Douglas & Jenkins Schedule C). Petitioners also included

Schedule C with respect to Ms. Douglas’ sole ownership of Apple Pie Mortgage

(Apple Pie Mortgage Schedule C) with each of the 2007 return (2007 Apple Pie

Mortgage Schedule C), the 2008 return (2008 Apple Pie Mortgage Schedule C),

and the 2009 return (2009 Apple Pie Mortgage Schedule C).

      In the 2007 Douglas & Jenkins Schedule C, petitioners reported “Gross re-

ceipts or sales” of $70,200 and “Cost of goods sold” of $56,307 and claimed

“Total expenses” of $40,847 (2007 Douglas & Jenkins claimed Schedule C ex-

penses). The 2007 Douglas & Jenkins claimed Schedule C expenses consisted of

the following:
                                        - 10 -

[*10]

                           Expense                  Amount
               Advertising                             $350
               Car and truck expenses                 6,637
               Contract labor                         4,000
               Depreciation and sec.
                179 expense deduction                 1,137
               Interest                               4,687
               Repairs and maintenance                  895
               Supplies                               6,334
               Taxes and licenses                     2,400
               Utilities                             14,407
                Total                                40,847

The 2007 Douglas & Jenkins claimed Schedule C expenses are not equal to 50

percent of the “Total deductions” that Douglas & Jenkins claimed in the 2007

Form 1120S.

        In the 2007 Apple Pie Mortgage Schedule C, petitioners reported “Gross re-

ceipts or sales” of $39,724 (2007 Apple Pie Mortgage reported Schedule C gross

receipts) and claimed “Total expenses” of $48,570 (2007 Apple Pie Mortgage

claimed Schedule C expenses) and “Expenses for business use of your home” of
                                       - 11 -

[*11] $431. The 2007 Apple Pie Mortgage claimed Schedule C expenses

consisted of the following:

                       Expense                    Amount
             Advertising                           $3,800
             Car and truck expenses                 3,845
             Depreciation and sec.
              179 expense deduction                   850
             Legal and professional
              services                              3,600
             Rent or lease                         10,800
             Supplies                              21,150
             Taxes and licenses                       600
             Travel, meals, and
              entertainment                           825
             Utilities                              3,100
               Total                               48,570

      In the 2008 Douglas & Jenkins Schedule C, petitioners reported “Gross re-

ceipts or sales” of negative $6,065 (2008 Douglas & Jenkins reported Schedule C

gross receipts) and claimed “Total expenses” of $19,709 (2008 Douglas & Jenkins

claimed Schedule C expenses). The 2008 Douglas & Jenkins claimed Schedule C

expenses consisted of the following:
                                        - 12 -

[*12]

                           Expense                  Amount
               Car and truck expenses                $5,509
               Repairs and maintenance                5,500
               Supplies                               2,800
               Travel, meals, and
                entertainment                         1,800
               Utilities                              4,100
                 Total                               19,709

The respective 2008 Douglas & Jenkins reported Schedule C gross receipts and

the 2008 Douglas & Jenkins claimed Schedule C expenses are not equal to 50 per-

cent of the “Gross receipts or sales” that Douglas & Jenkins reported and 50 per-

cent of the “Total deductions” that it claimed in the 2008 Form 1120S.

        In the 2008 Apple Pie Mortgage Schedule C, petitioners reported “Gross re-

ceipts or sales” of $24,895 (2008 Apple Pie Mortgage reported Schedule C gross

receipts) and claimed “Total expenses” of $32,715 (2008 Apple Pie Mortgage

claimed Schedule C expenses) and “Expenses for business use of your home” of

$1,143. The 2008 Apple Pie Mortgage claimed Schedule C expenses consisted of

the following:
                                        - 13 -

[*13]

                        Expense                    Amount
               Car and truck expenses               $4,065
               Legal and professional
                services                              3,600
               Rent or lease                        10,200
               Supplies                             10,100
               Taxes and licenses                     1,800
               Utilities                              2,950
                Total                               32,715

        In the 2009 Douglas & Jenkins Schedule C, petitioners reported no “Gross

receipts or sales” and claimed “Total expenses” of $12,545 (2009 Douglas &

Jenkins claimed Schedule C expenses). The 2009 Douglas & Jenkins claimed

Schedule C expenses consisted of the following:

                        Expense                    Amount
               Car and truck expenses               $7,345
               Utilities                              5,200
                Total                               12,545

The 2009 Douglas & Jenkins claimed Schedule C expenses are not equal to 50

percent of the “Total deductions” that Douglas & Jenkins claimed in the 2009

Form 1120S.
                                       - 14 -

[*14] In the 2009 Apple Pie Mortgage Schedule C, petitioners reported “Gross re-

ceipts or sales” of $27,255 (2009 Apple Pie Mortgage reported Schedule C gross

receipts) and claimed “Total expenses” of $45,799 (2009 Apple Pie Mortgage

claimed Schedule C expenses) and “Expenses for business use of your home” of

$2,298. The 2009 Apple Pie Mortgage claimed Schedule C expenses consisted of

the following:

                         Expense                    Amount
              Car and truck expenses                 $6,164
              Legal and professional
               services                               4,500
              Rent or lease                          12,300
              Supplies                               16,735
              Taxes and licenses                      2,900
              Utilities                               3,200
                 Total                               45,799

      Petitioners also included Schedule E, Supplemental Income and Loss

(Schedule E), with each of the 2008 return (2008 Schedule E) and the 2009 return

(2009 Schedule E). In the 2008 Schedule E, petitioners reported “Total rental real

estate and royalty income or (loss)” of negative $6,125 with respect to the Pike

Creek property.
                                       - 15 -

[*15] In the 2009 Schedule E, petitioners reported “Rents received” of $5,400 and

“Total rental real estate and royalty income or (loss)” of negative $14,395 with

respect to the Pike Creek property. In that Schedule E, petitioners also reported a

nonpassive loss of $10,303 that is attributable to Douglas & Jenkins (2009

claimed Douglas & Jenkins loss). The 2009 claimed Douglas & Jenkins Schedule

E loss was shown in Schedule K-1, Shareholder’s Share of Income, Deductions,

Credits, etc., that Mr. Douglas received from Douglas & Jenkins for his taxable

year 2009 and was equal to 50 percent of the loss of $20,606 that Douglas &

Jenkins claimed in the 2009 Form 1120S.

      Around June of 2010, respondent commenced an examination of petition-

ers’ 2008 return (respondent’s examination). Respondent later expanded that

examination to include petitioners’ 2007 return and 2009 return.

      During respondent’s examination, petitioners provided respondent’s reve-

nue agent assigned to that examination with, inter alia, (1) the Apple Pie Mortgage

audit reports and (2) general ledgers (Apple Pie Mortgage general ledgers) that

Ms. Douglas maintained for Apple Pie Mortgage for 2007, 2008, and 2009, re-

spectively. The revenue agent examined the Apple Pie Mortgage audit reports and

the Apple Pie Mortgage general ledgers and determined that the respective

amounts of “Total Loan revenue” and “Total Operating expenses” for 2007, 2008,
                                         - 16 -

[*16] and 2009 that were shown in the Apple Pie Mortgage audit reports were

essentially the same as the respective total amounts of gross receipts and expenses

for those years that were shown in the Apple Pie Mortgage general ledgers. On

the basis of his review of the information in the Apple Pie Mortgage audit reports

and the Apple Pie Mortgage general ledgers, the revenue agent concluded that

Apple Pie Mortgage has gross receipts of $120,746,2 $119,072, and $93,7993 and

expenses totaling $55,527, $52,825, and $46,9544 for 2007, 2008, and 2009,


      2
       As discussed below, the determinations that respondent made in the notice
of deficiency (notice) with respect to Apple Pie Mortgage for 2007 are based on
the revenue agent’s conclusion that Apple Pie Mortgage has gross receipts of
$120,746 for that year.
      3
       The respective amounts of gross receipts that the revenue agent concluded
Apple Pie Mortgage has for 2007, 2008, and 2009 are greater than the respective
amounts of the 2007 Apple Pie Mortgage reported Schedule C gross receipts, the
2008 Apple Pie Mortgage reported Schedule C gross receipts, and the 2009 Apple
Pie Mortgage reported Schedule C gross receipts. (We shall refer to the respective
differences between (1) the gross receipts of $120,746 that the revenue agent con-
cluded Apple Pie Mortgage has for 2007 and the 2007 Apple Pie Mortgage re-
ported Schedule C gross receipts of $39,724, i.e., $81,022, as the 2007 Apple Pie
Mortgage unreported gross receipts, (2) the gross receipts of $119,072 that the
revenue agent concluded Apple Pie Mortgage has for 2008 and the 2008 Apple Pie
Mortgage reported Schedule C gross receipts of $24,895, i.e., $94,177, as the 2008
Apple Pie Mortgage unreported gross receipts, and (3) the gross receipts of
$93,799 that the revenue agent concluded Apple Pie Mortgage has for 2009 and
the 2009 Apple Pie Mortgage reported Schedule C gross receipts of $27,255, i.e.,
$66,544, as the 2009 Apple Pie Mortgage unreported gross receipts.)
      4
          The respective total amounts of expenses that the revenue agent concluded
                                                                        (continued...)
                                       - 17 -

[*17] respectively. Thus, according to the revenue agent, Apple Pie Mortgage has

net income of $65,219, $66,247, and $46,845 for 2007, 2008, and 2009,

respectively.

      As part of respondent’s examination, the revenue agent asked petitioners for

(1) certain documents pertaining to petitioners’ 2007 return, petitioners’ 2008

return, and petitioners’ 2009 return and (2) the respective books and records of

Douglas & Jenkins for its taxable years 2007, 2008, and 2009. Petitioners did not

provide the revenue agent with those documents and books and records. Conse-

quently, the revenue agent issued summonses on behalf of respondent (respon-

dent’s summonses) to (1) the respective banks at which petitioners maintained

petitioners’ bank accounts and (2) the Club Escalade vendors. Pursuant to respon-


      4
        (...continued)
Apple Pie Mortgage has for 2007, 2008, and 2009 are greater than the respective
amounts of the 2007 Apple Pie Mortgage claimed Schedule C expenses, the 2008
Apple Pie Mortgage claimed Schedule C expenses, and the 2009 Apple Pie Mort-
gage claimed Schedule C expenses. However, those respective total amounts of
expenses are less than the respective total amounts of expenses shown for Apple
Pie Mortgage for 2007, 2008, and 2009 in the Apple Pie Mortgage audit reports
and the Apple Pie Mortgage general ledgers. In determining the total amount of
expenses shown in the Apple Pie Mortgage audit reports and the Apple Pie Mort-
gage general ledgers for each of the years 2007, 2008, and 2009 that the revenue
agent allowed as deductions for each of those years, the revenue agent did not
allow deductions for certain of those expenses for each of the years 2007, 2008,
and 2009 that he concluded were not “reasonable, ordinary and necessary”, such
as clothing, marketing gifts, gasoline, and vehicle repairs.
                                        - 18 -

[*18] dent’s summonses, those banks provided the revenue agent with the bank

statements for the respective bank accounts that petitioners maintained during

2007, 2008, and 2009 (petitioners’ bank statements), and those vendors provided

the revenue agent with invoices for the alcoholic beverages, nonalcoholic

beverages, and food that Douglas & Jenkins purchased for Club Escalade during

2007, 2008, and 2009, respectively (Club Escalade invoices).

      The revenue agent examined petitioners’ bank statements and prepared

respective bank deposits analyses for petitioners’ taxable years 2007, 2008, and

2009 on the basis of that examination (respondent’s bank deposits analyses).

Those respective bank deposits analyses showed, inter alia, the total amount of

deposits into each of petitioners’ bank accounts during each month in 2007, 2008,

and 2009. In preparing respondent’s bank deposits analyses, the revenue agent

attempted to ascertain whether any of the deposits into petitioners’ bank accounts

during 2007, 2008, and 2009 is nontaxable because, for example, a deposit had

been made as a result of a transfer of funds from one of petitioners’ bank accounts

to another of those accounts.

      For petitioners’ taxable year 2007, the revenue agent reduced the total de-

posits into petitioners’ bank accounts by (1) all deposits that the revenue agent

concluded are nontaxable, (2) the “Wages, salaries, tips, etc.” of $52,652 that peti-
                                        - 19 -

[*19] tioners reported in the 2007 return, (3) the “Taxable interest” of $1,075 that

petitioners reported in the 2007 return, (4) the 2007 Apple Pie Mortgage reported

Schedule C gross receipts of $39,724, and (5) the 2007 Apple Pie Mortgage unre-

ported gross receipts of $81,022.5 The revenue agent concluded that the balance

of the total deposits, i.e., $19,020, constituted unreported income for petitioners’

taxable year 2007.

      For petitioners’ taxable year 2008, the revenue agent reduced the total de-

posits into petitioners’ bank accounts by (1) all deposits that the revenue agent

concluded are nontaxable, (2) the “Wages, salaries, tips, etc.” of $52,931 that peti-

tioners reported in the 2008 return, (3) the “Taxable interest” of $1,863 that peti-

tioners reported in the 2008 return, (4) the “Other income” of $2,260 that petition-

ers reported in the 2008 return, (5) the 2008 Apple Pie Mortgage reported Sched-

ule C gross receipts of $24,895, and (6) the 2008 Apple Pie Mortgage unreported

gross receipts of $94,177.6 The revenue agent concluded that the balance of the




      5
       The revenue agent had already included the 2007Apple Pie Mortgage unre-
ported gross receipts in the Schedule C gross receipts of Apple Pie Mortgage for
2007.
      6
       The revenue agent had already included the 2008 Apple Pie Mortgage un-
reported gross receipts in the Schedule C gross receipts of Apple Pie Mortgage for
2008.
                                        - 20 -

[*20] total deposits, i.e., $42,111, constituted unreported income for petitioners’

taxable year 2008.

      For petitioners’ taxable year 2009, the revenue agent reduced the total de-

posits into petitioners’ bank accounts by (1) all deposits that the revenue agent

concluded are nontaxable, (2) the “Wages, salaries, tips, etc.” of $54,629 that peti-

tioners reported in the 2009 return, (3) the “Taxable interest” of $219 that petition-

ers reported in the 2009 return, (4) the 2009 Apple Pie Mortgage reported Sched-

ule C gross receipts of $27,255, (5) the “Rents received” of $5,400 that petitioners

reported in the 2009 Schedule E, and (6) the 2009 Apple Pie Mortgage unreported

gross receipts of $66,544.7 The revenue agent concluded that the balance of the

total deposits, i.e., $22,210, constituted unreported income for petitioners’ taxable

year 2009.

      The revenue agent also examined the Club Escalade invoices and prepared

respective percentage markup analyses for Douglas & Jenkins for its taxable years

2007, 2008, and 2009 on the basis of that examination (respondent’s percentage

markup analyses). In preparing respondent’s percentage markup analyses, the rev-

enue agent first determined Douglas & Jenkins’ cost of goods sold for each of its

      7
       The revenue agent had already included the 2009 Apple Pie Mortgage un-
reported gross receipts in the Schedule C gross receipts of Apple Pie Mortgage for
2009.
                                       - 21 -

[*21] taxable years 2007, 2008, and 2009 by (1) adding to the beginning inventory

that Douglas & Jenkins reported in Form 1120S that it filed for each of those

taxable years the purchases that it made during each such year pursuant to the

Club Escalade invoices and (2) subtracting the ending inventory that it reported

for each of those taxable years in each such Form 1120S. The revenue agent

determined Douglas & Jenkins’ gross receipts and expenses for each of its taxable

years 2007, 2008, and 2009 by multiplying the cost of goods sold that it

determined Douglas & Jenkins has for each of those taxable years by certain

percentages determined by the respective ratios of (a) cost of goods sold to gross

receipts and (b) expenses to gross receipts that were shown for similar businesses

on a Web site known as BizStats.8

      For Douglas & Jenkins’ taxable year 2007, the revenue agent determined

that Douglas & Jenkins has gross receipts of $150,794, cost of goods sold of

$59,790, “Gross Profit” of $91,004, and expenses of $80,358. The revenue agent

further determined (1) that the difference between the “Gross Profit” of $91,004

and the expenses of $80,358 that he determined Douglas & Jenkins has for its tax-


      8
        According to its Web site, BizStats collects and analyzes public data to
provide a free online source for small business statistics. See BizStats,
http://www.bizstats.com (follow “About” hyperlink) (last visited April 1, 2014).
The Brandow Co. owns and operates BizStats. Id.
                                       - 22 -

[*22] able year 2007, i.e., $10,646, constituted “Ordinary Income” of Douglas &

Jenkins for that taxable year and (2) that Mr. Douglas’ 50 percent share of that

“Ordinary Income” for that taxable year was $5,323.

      For Douglas & Jenkins’ taxable year 2008, the revenue agent determined

that Douglas & Jenkins has gross receipts of $126,620, cost of goods sold of

$50,205, “Gross Profit” of $76,415, and expenses of $67,476. The revenue agent

further determined (1) that the difference between the “Gross Profit” of $76,415

and the expenses of $67,476 that he determined Douglas & Jenkins has for its tax-

able year 2008, i.e., $8,939, constituted “Ordinary Income” of Douglas & Jenkins

for that taxable year and (2) that Mr. Douglas’ 50 percent share of that “Ordinary

Income” for that taxable year was $4,470.

      For Douglas & Jenkins’ taxable year 2009, the revenue agent determined

that Douglas & Jenkins has gross receipts of $78,124, cost of goods sold of

$30,976, “Gross Profit” of $47,148, and expenses of $41,632. The revenue agent

further determined (1) that the difference between the “Gross Profit” of $47,148

and the expenses of $41,632 that he determined Douglas & Jenkins has for its tax-

able year 2009, i.e., $5,516, constituted “Ordinary Income” of Douglas & Jenkins

for that taxable year and (2) that Mr. Douglas’ 50 percent share of that “Ordinary

Income” for that taxable year was $2,758.
                                        - 23 -

[*23] Respondent issued to petitioners a notice for their taxable years 2007, 2008,

and 2009. In that notice, respondent determined that petitioners have unreported

Schedule C gross receipts that are attributable to Apple Pie Mortgage of $25,495,

$41,352, and $19,590 for their taxable years 2007, 2008, and 2009, respectively.

Respondent also determined in the notice to disallow all of the expenses that peti-

tioners claimed in the respective Schedules C for Apple Pie Mortgage that they

attached to their 2007 return, their 2008 return, and their 2009 return.9 The deter-

minations that respondent made in the notice with respect to Apple Pie Mortgage

resulted in petitioners’ having net income that is attributable to that company of




      9
        During respondent’s examination, the revenue agent concluded that Apple
Pie Mortgage has increased gross receipts of $120,746, $119,072, and $93,799
and increased expenses of $55,527, $52,825, and $46,954 for 2007, 2008, and
2009, respectively. Thus, according to the revenue agent, petitioners have net in-
come that is attributable to Apple Pie Mortgage of $65,219, $66,247, and $46,845
for their taxable years 2007, 2008, and 2009, respectively. As discussed in the
text, respondent made determinations in the notice with respect to Apple Pie Mort-
gage that also resulted in petitioners’ having net income that is attributable to that
company of $65,219, $66,247, and $46,845 for their taxable years 2007, 2008, and
2009, respectively. However, respondent made those determinations in a bizarre
manner. Instead of increasing the gross receipts that petitioners reported and the
expenses that petitioners claimed that are attributable to Apple Pie Mortgage for
their taxable years 2007, 2008, and 2009, respectively, respondent determined in
the notice to disallow all of those claimed expenses and increase those reported
gross receipts by amounts that are significantly less than the amount by which the
revenue agent increased those reported gross receipts for each of petitioners’ tax-
able years 2007, 2008, and 2009.
                                       - 24 -

[*24] $65,219, $66,247, and $46,845 for their taxable years 2007, 2008, and 2009,

respectively.

      In the notice, respondent determined that petitioners should not have re-

ported gross receipts and/or claimed expenses that are attributable to Douglas &

Jenkins in Schedule C for each of their taxable years 2007, 2008, and 2009.10

Respondent further determined that petitioners should have reported in Schedule E

net income that is attributable to Douglas & Jenkins of $5,323, $4,470, and $2,758

for their taxable years 2007, 2008, and 2009, respectively.11 The net income that

is attributable to Douglas & Jenkins that respondent determined in the notice peti-

tioners have for their respective taxable years 2007 and 2008 is the same as the net


      10
        It is unclear why petitioners reported gross receipts and/or claimed ex-
penses that are attributable to Douglas & Jenkins in Schedule C for each of their
taxable years 2007, 2008, and 2009 when petitioners were required to report
claimed net income or a claimed loss that is attributable to Douglas & Jenkins in
Schedule E for each of those years. As discussed in the text, they reported a
claimed loss of $10,303 that is attributable to Douglas & Jenkins in the 2009
Schedule E and a claimed loss of $12,545 in the 2009 Douglas & Jenkins Sched-
ule C.
      11
         In support of respondent’s determinations with respect to Douglas & Jen-
kins, respondent stated in the notice: “It is determined that the loss flow-through
from your S Corporation, Douglas & Jenkins DBA Club Escalade is $5,323.00,
$4,470.00 and $13,061.00”. That statement is incorrect insofar as it refers to any
“loss flow-through from * * * Douglas & Jenkins”. As made clear elsewhere in
the notice, respondent determined that petitioners have unreported net income of
$5,323, $4,470, and $2,758 that is attributable to Douglas & Jenkins for the re-
spective taxable years at issue.
                                        - 25 -

[*25] income that is attributable to that corporation that the revenue agent

concluded petitioners have for those respective years. The net income that is

attributable to Douglas & Jenkins that respondent determined in the notice

petitioners have for their taxable year 2009 is also the same as the net income that

is attributable to that corporation that the revenue agent concluded petitioners have

for that year.12

       In the notice, respondent further determined that for their taxable years

2007, 2008, and 2009 petitioners have unreported income of $20,285, $44,395,

and $22,210, respectively.13



       12
         However, respondent made the determination of petitioners’ net income of
$2,758 that is attributable to Douglas & Jenkins for their taxable year 2009 in a
bizarre manner. See supra note 9. In the notice, respondent did not disallow the
nonpassive loss of $10,303 that petitioners claimed in the 2009 Schedule E is attri-
butable to Douglas & Jenkins. Instead, respondent determined to increase “Sch E-
Inc/Loss-Prtnrship/S Corps-Passve/Non-Passve” by $13,061, which resulted in
petitioners’ having net income that is attributable to Douglas & Jenkins of $2,758
for their taxable year 2009, the same amount that the revenue agent concluded
they have for that taxable year.
       13
        In making the determination that for their taxable years 2007, 2008, and
2009 petitioners have unreported income of $20,285, $44,395, and $22,210, re-
spectively, respondent relied on respondent’s bank deposits analyses that the rev-
enue agent had prepared. In this connection, respondent conceded at the trial in
this case that for their respective taxable years 2007 and 2008 petitioners have un-
reported income of $19,020 and $42,111 as the revenue agent concluded on the
basis of respondent’s bank deposits analyses, and not $20,285 and $44,395 as re-
spondent determined in the notice.
                                        - 26 -

[*26] Respondent also determined in the notice that petitioners (1) are not entitled

for their taxable year 2008 to the first-time homebuyer credit under section 36(a)14

and (2) are liable for each of their taxable years 2007, 2008, and 2009 for the

accuracy-related penalty under section 6662(a).

                                     OPINION

      Petitioners bear the burden of establishing that the determinations in the

notice that remain at issue are erroneous. See Rule 142(a); Welch v. Helvering,

290 U.S. 111, 115 (1933). Moreover, deductions are a matter of legislative grace,

and petitioners bear the burden of proving entitlement to any deduction claimed.

See INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). The Code and the

regulations thereunder required petitioners to maintain records sufficient to estab-

lish the amount of any deduction claimed. See sec. 6001; sec. 1.6001-1(a), Income

Tax Regs.

      We turn initially to the issue presented with respect to Apple Pie Mortgage.

As we understand petitioners’ position, petitioners maintain that they have a loss

      14
        In the notice, respondent determined to increase petitioners’ tax for their
taxable year 2008 by $7,800 as a result of respondent’s determination that peti-
tioners are not entitled for their taxable year 2008 to the first-time homebuyer
credit under sec. 36(a). Petitioners claimed a first-time homebuyer credit of
$7,500, and not $7,800, for their taxable year 2008. Respondent’s error in the
notice should be corrected in the computations under Rule 155 that will be re-
quired in order for us to enter a decision in this case.
                                        - 27 -

[*27] that is attributable to Apple Pie Mortgage for each of their taxable years

2007, 2008, and 2009, not net income for each of those years as respondent

determined in the notice.15

      Except for certain uncorroborated testimony of Ms. Douglas at trial, peti-

tioners presented no evidence establishing that they have a loss that is attributable

to Apple Pie Mortgage for each of their taxable years 2007, 2008, and 2009. We

shall not rely on the uncorroborated testimony of Ms. Douglas to establish peti-

tioners’ position that they have losses that are attributable to Apple Pie Mortgage

for those respective years. See, e.g., Tokarski v. Commissioner, 87 T.C. 74, 77

(1986).

      Based upon our examination of the entire record before us, we find that

petitioners have failed to carry their burden of establishing that they did not have

net income that is attributable to Apple Pie Mortgage of $65,219, $66,247, and

$46,845 for their taxable years 2007, 2008, and 2009, respectively.

      We turn next to the issue presented with respect to Douglas & Jenkins. As

we understand petitioners’ position, petitioners maintain that they have a loss that

is attributable to Douglas & Jenkins for each of their taxable years 2007, 2008,

      15
         Although given the opportunity to do so, petitioners did not file any briefs
in this case. Our understanding of petitioners’ position is based upon their pretrial
memorandum and their respective testimonies at the trial in this case.
                                        - 28 -

[*28] and 2009, not net income for each of those years as respondent determined

in the notice.16

       Except for certain uncorroborated testimony of Mr. Douglas at trial, peti-

tioners presented no evidence establishing that they have a loss that is attributable

to Douglas & Jenkins for each of their taxable years 2007, 2008, and 2009. We

shall not rely on the uncorroborated testimony of Mr. Douglas to establish peti-

tioners’ position that they have losses that are attributable to Douglas & Jenkins

for those respective years. See, e.g., Tokarski v. Commissioner, 87 T.C. at 77.

       Based upon our examination of the entire record before us, we find that pe-

titioners have failed to carry their burden of establishing that they did not have net

income that is attributable to Douglas & Jenkins of $5,323, $4,470, and $2,758 for

their taxable years 2007, 2008, and 2009, respectively.17




       16
            See supra note 15.
       17
         Assuming arguendo that we had found that petitioners had losses that are
attributable to Douglas & Jenkins for their taxable years 2007, 2008, and 2009,
respectively, petitioners would be entitled to deduct those losses only to the extent
of the sum of Mr. Douglas’ adjusted basis in his stock of Douglas & Jenkins and
his adjusted basis in any indebtedness of that corporation to him. See sec.
1366(d)(1)(A) and (B). Petitioners did not introduce any evidence to establish Mr.
Douglas’ adjusted basis in his stock of Douglas & Jenkins and his adjusted basis
in any indebtedness of that corporation to him.
                                         - 29 -

[*29] We turn next to whether petitioners have certain unreported income for each

of their taxable years 2007, 2008, and 2009 that respondent determined on the ba-

sis of the bank deposits method. As we understand petitioners’ position, petition-

ers maintain that they do not.18

      Except for certain uncorroborated testimony of Ms. Douglas at trial, peti-

tioners presented no evidence establishing that they do not have the unreported

income that respondent determined on the basis of the bank deposits method for

each of their taxable years 2007, 2008, and 2009. We shall not rely on the uncor-

roborated testimony of Ms. Douglas to establish petitioners’ position that they do

not have that unreported income for those respective taxable years. See, e.g., id.

      Based upon our examination of the entire record before us, we find that pe-

titioners have failed to carry their burden of establishing that they did not have the

unreported income that respondent determined on the basis of the bank deposits

method of $19,020, $42,111, and $22,210 for their taxable years 2007, 2008, and

2009, respectively.

      We turn now to the first-time homebuyer credit under section 36(a) that pe-

titioners are claiming for their taxable year 2008. It is petitioners’ position that

they are entitled to that credit for their taxable year 2008 with respect to the Lone

      18
           See supra note 15.
                                        - 30 -

[*30] Tree property.19 In support of that position, petitioners rely on the testimony

of Ms. Douglas that “[n]either one of us [petitioners] owned a home” since 2002.

      As pertinent here, an individual taxpayer who is a first-time homebuyer of a

principal residence in the United States is entitled to a credit in an amount equal to

10 percent of the purchase price of the principal residence, sec. 36(a), but such

amount is not to exceed $7,500, sec. 36(b)(1)(A). As pertinent here, the credit is

applicable only if the taxpayer “purchased” the principal residence on or after

April 9, 2008, and before July 1, 2009. Sec. 36(h).

      The term “first-time homebuyer” is defined in section 36(c)(1) to mean “any

individual if such individual (and if married, such individual’s spouse) had no

present ownership interest in a principal residence during the 3-year period ending

on the date of the purchase of the principal residence to which this section ap-

plies.”

      Respondent acknowledges that “petitioner George B. Douglas, Jr. will qual-

if[y] as a first-time homebuyer” within the meaning of section 36(c)(1). However,

respondent maintains that petitioners are not entitled for their taxable year 2008 to

the first-time homebuyer credit with respect to the Lone Tree property because




      19
           See supra note 15.
                                       - 31 -

[*31] Ms. Douglas does not qualify as a first-time homebuyer within the meaning

of that section. According to respondent:

             The evidence supports that Pearl J. Douglas retained the bene-
      fits and burdens of ownership [of the Pike Creek property], in fact,
      she never relinquished them after the quitclaim deed. Even after the
      legal transfer, she continued to reside in the property and she main-
      tained and paid the property’s insurance, electric and trash expenses,
      and property taxes. * * * Even after [q]uitclaiming her interest, peti-
      tioners reported rental activity for this property on a Schedule E in
      2008 and 2009. Because Pearl Douglas retained the benefits and
      burdens of ownership, for purposes of section 36(c) she never relin-
      quished equitable ownership in the Pike Creek property. [Citations
      omitted.]

      On April 14, 2002, Ms. Douglas executed a quitclaim deed with respect to

the Pike Creek property to RB and JB. However, that fact is not determinative of

whether Ms. Douglas transferred ownership of the Pike Creek property to RB and

JB for tax purposes. To determine whether Ms. Douglas had an ownership interest

in that property after she executed a quitclaim deed with respect to it to RB and

JB, we will examine all the facts and circumstances. Cf. Grodt & McKay Realty,

Inc. v. Commissioner, 77 T.C. 1221, 1237 (1981).20 No single factor is control-

ling, and the focus of our inquiry is on whether the benefits and burdens of owner-

ship have shifted. Id. Among the factors that we consider in determining whether

the benefits and burdens of ownership have shifted are: (1) whether legal title

      20
           See also O’Malley v. Commissioner, T.C. Memo. 2007-79.
                                       - 32 -

[*32] passes, (2) how the parties treat the transaction; (3) whether an equity was

acquired in the property; (4) whether the contract creates a present obligation on

the seller to execute and deliver a deed and a present obligation on the purchaser

to make payments; (5) whether the right of possession is vested in the purchaser;

(6) which party pays the property taxes; (7) which party bears the risk of loss or

damage to the property; and (8) which party receives the profits from the operation

and sale of the property. Id. at 1237-1238.

      After Ms. Douglas executed the quitclaim deed, she continued to reside in

the Pike Creek house on the Pike Creek property until around September 10, 2008,

and continued to pay the expenses associated with the Pike Creek property, includ-

ing expenses for electricity, trash service, homeowners insurance, and real prop-

erty taxes. In addition, she and Mr. Douglas reported (1) “Total rental real estate

and royalty income or (loss)” of negative $6,125 with respect to the Pike Creek

property in the 2008 Schedule E and (2) “Rents received” of $5,400 and “Total

rental real estate and royalty income or (loss)” of negative $14,395 with respect to

the Pike Creek property in the 2009 Schedule E. Those actions are consistent with

Ms. Douglas’ having retained the benefits and burdens of ownership of the Pike

Creek property after she executed a quitclaim deed with respect to that property to

RB and JB.
                                         - 33 -

[*33] On the record before us, we find that Ms. Douglas retained the benefits and

burdens of ownership of the Pike Creek property after she executed the quitclaim

deed and had a present ownership interest in the Pike Creek property during the

three-year period that ended on September 10, 2008, the date on which Mr. Doug-

las purchased the Lone Tree property. On the record before us, we find that Ms.

Douglas does not qualify as a “first-time homebuyer” within the meaning of sec-

tion 36(c)(1).

      Based upon our examination of the entire record before us, we find that

petitioners are not entitled for their taxable year 2008 to the first-time homebuyer

credit under section 36(a).

      We turn next to the issue presented under section 6662(a). Section 6662(a)

imposes an accuracy-related penalty of 20 percent on the underpayment to which

section 6662 applies. Section 6662 applies to the portion of any underpayment

which is attributable to, inter alia, (1) negligence or disregard of rules or regula-

tions, sec. 6662(b)(1), or (2) a substantial understatement of tax, sec. 6662(b)(2).

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

reasonable attempt to comply with the Code. Sec. 6662(c). Negligence has also

been defined as a failure to do what a reasonable person would do under the cir-

cumstances. See Leuhsler v. Commissioner, 963 F.2d 907, 910 (6th Cir. 1992),
                                        - 34 -

[*34] aff’g T.C. Memo. 1991-179; Antonides v. Commissioner, 91 T.C. 686, 699

(1988), aff’d, 893 F.2d 656 (4th Cir. 1990). The term “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. The term “disregard” in-

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

      For purposes of section 6662(b)(2) an understatement is equal to the excess

of the amount of tax required to be shown in the tax return over the amount of tax

shown in the return. Sec. 6662(d)(2)(A). An understatement is substantial in the

case of an individual if the amount of the understatement for the taxable year ex-

ceeds the greater of 10 percent of the tax required to be shown in the tax return for

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

      The accuracy-related penalty under section 6662(a) does not apply to any

portion of an underpayment if it is shown that there was reasonable cause for, and

that the taxpayer acted in good faith with respect to, such portion. Sec.

6664(c)(1). The determination of whether the taxpayer acted with reasonable

cause and in good faith depends on all the pertinent facts and circumstances,

including the taxpayer’s efforts to assess the taxpayer’s proper tax liability, the

knowledge and experience of the taxpayer, and the reliance on the advice of a

professional, such as an accountant. Sec. 1.6664-4(b)(1), Income Tax Regs.
                                        - 35 -

[*35] Reliance on the advice of a professional may demonstrate reasonable cause

and good faith if, under all the circumstances, such reliance was reasonable and

the taxpayer acted in good faith. Id. In this connection, a taxpayer must demon-

strate that the taxpayer’s reliance on the advice of a professional concerning sub-

stantive tax law was objectively reasonable. See Goldman v. Commissioner, 39

F.3d 402, 408 (2d Cir. 1994), aff’g T.C. Memo. 1993-480. A taxpayer’s reliance

on the advice of a professional will be objectively reasonable only if the taxpayer

has provided necessary and accurate information to the professional. See

Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299

F.3d 221 (3d Cir. 2002); see also Ma-Tran Corp. v. Commissioner, 70 T.C. 158,

173 (1978).

      Respondent bears the burden of production with respect to the accuracy-

related penalties under section 6662(a) that respondent determined in the notice.

See sec. 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). To

satisfy respondent’s burden of production, respondent must come forward with

“sufficient evidence indicating that it is appropriate to impose” the penalty.

Higbee v. Commissioner, 116 T.C. at 446. Although respondent bears the burden

of production with respect to the penalty under section 6662(a), respondent “need
                                       - 36 -

[*36] not introduce evidence regarding reasonable cause * * * or similar

provisions. * * * the taxpayer bears the burden of proof with regard to those

issues.” Id.

      Respondent argues that petitioners are liable for each of the years at issue

for the accuracy-related penalty under section 6662(a) because of a substantial

understatement of tax under section 6662(b)(2) and petitioners’ negligence or

disregard of rules or regulations under section 6662(b)(1).

      On the record before us, we find that respondent has satisfied respondent’s

burden of production under section 7491(c) with respect to the accuracy-related

penalty under section 6662(a).21

      As we understand petitioners’ position, they maintain that under section

6664(c)(1) they had reasonable cause for, and acted in good faith with respect to,

the respective underpayments for their taxable years 2007, 2008, and 2009.22 In

support of that position, petitioners rely on the following testimony of Ms. Doug-

las (Ms. Douglas’ section 6662(a) testimony):



      21
         For example, petitioners failed to substantiate properly the respective
losses for each of their taxable years 2007, 2008, and 2009 that they claim are
attributable to Apple Pie Mortgage and Douglas & Jenkins. See sec. 1.6662-
3(b)(1), Income Tax Regs.
      22
           See supra note 15.
                                         - 37 -

      [*37] Again, my thing was, I thought we did the due diligence thing
      by going and having our returns revised to show that we did not earn
      --and the money that they’re saying, as well as we did not, at the end
      of the year, have a profit--

                 *         *     *      *         *   *      *

             So I--my objection to the penalty is that even though you’re
      saying that, you know, we didn’t prove it to the Court and doing the
      revised returns did not benefit us. I really--I guess that leaves me in a
      position I did not prove my case. But I thought we did do the right
      thing, I thought we was in our--within the law to be entitled. I feel
      like we were entitled to be able to file our revised returns

             And if so, we would not have had to come to Tax Court. And I
      know you’re saying that now that we’re here we have to prove to you,
      so that--you know, I have to accept that. But I feel like had we been
      able to not be misled by the IRS as to not being able to file the revised
      returns, we would have--our accountant, the CPA, would have filed
      our 1040X. It would have supported the fact that we did not inten-
      tonally understate-- [Reproduced literally.]

      On the record before us, we find that Ms. Douglas’ section 6662(a) testi-

mony does not establish that there was reasonable cause for, and that petitioners

acted in good faith with respect to, the respective underpayments for their taxable

years 2007, 2008, and 2009. On the record before us, we find that petitioners have

failed to carry their burden of establishing that there was reasonable cause for, and

that they acted in good faith with respect to, those underpayments.

      Based upon our examination of the entire record before us, we find that pe-

titioners have failed to carry their burden of establishing that they are not liable for
                                         - 38 -

[*38] each of their taxable years 2007, 2008, and 2009 for the accuracy-related

penalty under section 6662(a).

        We have considered all of the contentions and arguments of the parties that

are not discussed herein, and we find them to be without merit, irrelevant, and/or

moot.

        To reflect the foregoing, the concessions of the parties, and a certain error

that we found in the notice, see supra note 14,


                                                  Decision will be entered under

                                         Rule 155.
