                        T.C. Memo. 1997-466



                      UNITED STATES TAX COURT



       GREGORY A. MASLOW AND MARINA MASLOW, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 12960-94.                     Filed October 14, 1997.



     Gregory A. Maslow, pro se.

     Alan R. Peregoy, for respondent.



                         MEMORANDUM OPINION


     JACOBS, Judge:   Respondent determined a deficiency of $18,800

in petitioners' Federal income tax for 1992, an accuracy-related

penalty of $3,760 pursuant to section 6662, and an addition to tax

of $4,801 for failure to timely file pursuant to section 6651(a)(1)

for that year.   The determined deficiency arises from respondent's
                                  -2-

determination    that   petitioners   underreported     their    income   and

overstated Schedule C deductions for 1992.      The specific issues we

must resolve are:

     (1) Did petitioners underreport their income in 1992 by

$25,112?    Respondent determined this amount through the bank

deposits method, showing total deposits of $82,072,1 of which

$45,332 was reported by petitioners on their tax return and $11,628

was conceded by respondent at trial as nontaxable.              We find that

the $25,112 difference came from nontaxable sources; thus, we hold

that petitioners did not underreport their 1992 income by $25,112.

     (2)   Must petitioners include $7,220 in income, representing

the market value of a trip to Scotland and England petitioner

Gregory A. Maslow earned in 1992 as a sales award from Kentucky

Central Life Insurance Co.?     We hold they must.

     (3)   Are   petitioners   entitled   to   deduct    various     claimed

Schedule C business expenses that respondent disallowed? We hold

that petitioners are entitled to a portion, but not all, of the

claimed Schedule C business expenses, as explained in greater

detail infra.

     (4)   Are petitioners liable for the accuracy-related penalty

under section 6662 for 1992 and for an addition to tax for failure

     1
          The notice of deficiency states in one instance that
the deposits for 1992 total $80,096 and in another instance
$81,029. On brief, respondent states the total deposits as
$82,072. On the basis of our holding that the unidentified
deposits are not taxable, the differing deposit amounts are of no
importance.
                                      -3-

to   timely   file   their   1992   income     tax    return   under   section

6651(a)(1)?    We hold petitioners are liable for both the penalty

and the addition to tax.

      All section references are to the Internal Revenue Code for

the year under consideration.         All Rule references are to the Tax

Court Rules of Practice and Procedure.               All dollar amounts are

rounded.

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

stipulation of facts and the attached exhibits are incorporated

herein by this reference. For convenience, we present a background

section and combine our findings of fact with our opinion under

separate issue headings.

                                Background

      Petitioners,    husband   and    wife,    resided   in   Randallstown,

Maryland, at the time they filed their petition. Gregory A. Maslow

(petitioner) emigrated to the United States from Russia in 1974.

He and Marina met (in 1986) and married (in 1988) in the United

States.

      During 1992, the year under consideration, petitioner was a

general agent for several life and health insurance companies.              In

addition, during 1992 he started a business (known as East-West

International) which was to engage in the export of goods to

Russia.

      Petitioners did not file Federal income tax returns for 1988

through 1992 until they were contacted by one of respondent's
                                         -4-

revenue agents (Revenue Agent Bank) in the fall of 1993.                      As a

result, on October 12, 1993, petitioners filed delinquent tax

returns for 1988, 1989, 1990, and 1991.              On November 5, 1993, they

filed their 1992 tax return.

        Petitioner did not maintain books or records pertaining to his

insurance business.        Petitioners did, however, maintain a checking

account at Maryland National Bank under the name Graded Assets

Management.        This account was used for both business and personal

purposes.        Petitioner    provided    Revenue     Agent   Bank   with    bank

statements and canceled checks that detailed most, if not all, of

his 1992 business activities.

Issue 1. Did Petitioners Underreport Their 1992 Income by $25,112?

     Due to the absence of adequate books and records, Revenue

Agent Bank reconstructed petitioners' 1992 income using a bank

deposits analysis. Through the use of this analysis, Revenue Agent

Bank determined that petitioners underreported their 1992 income by

$34,764.     The    $34,764     represents     the   difference     between    the

aggregate amount of deposits to petitioners' Maryland National Bank

checking account ($80,096)2 and the income petitioners reported on

their     1992     tax   return    ($45,332)    (the    difference    being    the

unidentified deposits). At trial, respondent conceded that $11,628

of   the    original      amount    of   unidentified    deposits     came    from

nontaxable sources.           Hence, respondent now asserts there is only


     2
             See supra note 1.
                                          -5-

$25,1123 ($82,072 - $45,332 - $11,628) of unidentified deposits.

       The    use   of    bank   deposits    to    reconstruct   income     is   well

established. DiLeo v. Commissioner, 96 T.C. 858, 867 (1991), affd.

959 F.2d 16 (2d Cir. 1992); Parks v. Commissioner, 94 T.C. 654, 658

(1990); Nicholas v. Commissioner, 70 T.C. 1057, 1064 (1978); Estate

of Mason v. Commissioner, 64 T.C. 651, 656 (1975), affd. 566 F.2d

2 (6th Cir. 1977).           "The bank deposits method assumes that all

money deposited in a taxpayer's bank account during a given period

constitutes taxable income."           DiLeo v. Commissioner, supra at 868.

But the making of a bank deposit per se does not mean that the

amount so deposited is income.            Goe v. Commissioner, 198 F.2d 851,

852 (3d Cir. 1952); Vuitch v. Commissioner, T.C. Memo. 1985-95.

However, where the Commissioner has determined that the deposits

constitute income, the taxpayer has the burden of showing the

Commissioner's determination was incorrect.                 See United States v.

Massei, 355 U.S. 595 (1958); Parks v. Commissioner, supra at 661.

       In    explaining     the   source     of    the    unidentified     deposits,

petitioner testified that he borrowed moneys in 1992 from various

finance companies--Chrysler First Co., Commercial Credit Corp., and

Rose       Shanis   Co.   Petitioner      also     testified   that   in    1992   he

periodically        received      money     from    his    father-in-law      (Roman

Shumatsky) totaling approximately $10,000 as well as from Roland

       3
          The differing amounts exist due to the inconsistency
between the amount of total bank deposits stated in the notice of
deficiency ($80,096 or $81,029) and respondent's brief ($82,072).
See supra note 1.
                                -6-

Butler, a business associate, totaling approximately $19,000, and

that he deposited these moneys into his bank account.    (Mr. Butler

and petitioner were to be involved in the export of coffee to

Russia.)   We found petitioner's testimony credible.

     Mr. Shumatsky also testified and corroborated petitioner's

testimony. (Petitioner testified that he was unable to reach Mr.

Butler in order for the latter to testify.)   We found the testimony

of Mr. Shumatsky credible.    No witnesses testified on behalf of

respondent.

     Our ultimate task is to distill truth from falsehood.       As

trier of facts, we "must be careful to avoid making the courtroom

a haven for the skillful liar or a quagmire in which the honest

litigant is swallowed up."   Diaz v. Commissioner, 58 T.C. 560, 564

(1972).

     On the basis of the testimony of petitioner and Mr. Shumatsky,

we are persuaded that the unexplained deposits came from Messrs.

Shumatsky and Butler. Hence, petitioners have shown respondent's

determination as to the taxability of the deposits to be incorrect.

Consequently, we hold that petitioners did not underreport their

1992 income   by $25,112, as determined by respondent.

Issue 2. Must Petitioners Include $7,220 Representing the Market
Value of a Trip to Scotland and England Earned by Petitioner as a
Sales Award in Income?

     Most of the insurance policies petitioner wrote were with

Kentucky Central Life Insurance Co.   In 1992, petitioner received

a free trip to Scotland and England for himself and his wife as a
                                      -7-

sales award from Kentucky Central Life Insurance Co.                  The fair

market   value   of    the   trip   was   $7,220,   which   was   reported   to

petitioner on a Form 1099.          Petitioners did not include the value

of this sales award in income.        Petitioner claims that the trip was

a "company conference" and that he was told by his superiors at the

home offices of Kentucky Central Life Insurance Co. that the trip

"was fully tax deductible".

     Except as otherwise provided by law, gross income includes all

income from whatever source derived.                Sec. 61.      Gross income

includes income realized in any form, whether money, property, or

services.   Sec. 1.61-1(a), Income Tax Regs.           Thus, if the taxpayer

performs services in exchange for another type of service or

receipt of property, then the taxpayer must include in his/her

income the fair market value of the services or property received.

Sec. 1.61-2(d)(1), Income Tax Regs. In the instant case, the sales

award received by petitioner represents compensation for services.

Hence, we hold that petitioner must include the $7,220 fair market

value of the trip (not his estimate of what the trip was worth) in

income for 1992.

Issue 3. Are Petitioners Entitled to Various Claimed Schedule C
Business Expenses That Respondent Disallowed?

     Respondent       disallowed    the   following    expenses    petitioners

claimed on Schedule C (Profit or Loss from Business) filed with

their 1992 tax return:
                                    -8-

  Type of Expense            Amount Claimed          Amount Disallowed

A.   Home-office                  $8,013                       $6,813
B.   Travel                        9,923                        7,220
C.   Insurance                     1,983                        1,983
D.   Phone                         5,709                        5,709
E.   Commissions                   5,184                        2,006

     A.    Home-Office Expenses

     The portion of the claimed home-office expenses disallowed by

respondent ($6,813) represents 6 months of home mortgage payments.

(Petitioner   claimed   he   used   50    percent   of   his    residence   for

business purposes.)     Both the home and the mortgage were in the

name of petitioner's father-in-law, Mr. Shumatsky.

     In general, section 280A denies a deduction with respect to a

home office used by persons such as petitioner unless the home

office is exclusively used on a regular basis either (1) as the

principal place of business for any trade or business of such a

person, (2) as a place of business which is used by patients,

clients, or customers in meeting or dealing with the person in the

normal course of the person's trade or business, or (3) in the case

of a separate structure that is not attached to the home, in

connection with the person's trade or business.

     Petitioner failed to prove that the portion of his home

claimed as an office expense was exclusively used on a regular

basis either as the principal place of his insurance or export

business or as a place of business used to meet customers or

clients.   See sec. 280A.    Indeed, the record shows that petitioner

did not meet his customers at his home but rather conducted his
                                       -9-

insurance activities by traveling to the homes of his customers.

The record further indicates that (1) petitioner occasionally, but

not regularly, met other insurance agents at his residence, and (2)

petitioner had an outside office for 3 months during 1992.

      Because petitioner did not satisfy the requirements of section

280A, we sustain respondent's disallowance of petitioners' $6,813

claimed home-office expenses.          See Commissioner v. Soliman, 506

U.S. 168 (1993).

      B.    Travel Expenses

      Respondent disallowed $7,220 of the claimed $9,923 travel

expenses,    determining     that    petitioners      deducted,      rather   than

included in income, the $7,220 travel award by Kentucky Central

Life Insurance Co. referred to supra. Respondent allowed the

balance     of   the   claimed   $9,923      travel   expenses    ($2,703)      as

automobile travel expenses incurred in connection with petitioner's

insurance business.

      Petitioner claims that $7,220 of the claimed travel expenses

relates to trips to Israel (February 13-16, 1992), Russia (May 16-

20,   1992),     Brussels   (September       15-24,   1992),   and    Luxembourg

(November 17, 1992), in connection with the startup of his export

business and has no connection with the travel award by Kentucky

Central Life Insurance Co.          Even if we accept petitioner's claim,

nonetheless, petitioner failed to substantiate the costs of those

trips.     See sec. 274(d)(1).       Moreover, petitioner did not file a

Schedule C for his export business activities.
                                     -10-

     Deductions are a matter of legislative grace, and in general

taxpayers bear the burden of proving that they are entitled to the

deductions claimed.    Rule 142(a); INDOPCO, Inc. v. Commissioner,

503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S.

435 (1934).     Taxpayers must keep sufficient records to establish

the amount of their deductions.             See sec. 6001; Meneguzzo v.

Commissioner, 43 T.C. 824, 831-832 (1965); sec. 1.6001-1(a), Income

Tax Regs.     Moreover, a taxpayer who claims a deduction bears the

burden of     substantiating   the    amount   and   purpose   of   the   item

claimed.    Hradesky v. Commissioner, 65 T.C. 87, 90 (1975), affd.

per curiam 540 F.2d 821 (5th Cir. 1976); sec. 1.6001-1(a), Income

Tax Regs.

     Because petitioner failed to substantiate his purported travel

costs, we sustain respondent's disallowance of the $7,220 in

question.     Moreover, insofar as the purported travel expenses

represent startup business costs, they would not be deductible in

1992 because petitioner's export business did not begin operations

until 1993.     See sec. 195; Garrett v. Commissioner, T.C. Memo.

1997-231.

     C. Insurance Expenses

     Respondent disallowed the claimed insurance expenses on the

basis that petitioner failed to substantiate the business purpose

of the deduction. Petitioner claims the insurance expenses related

to his automobile insurance; respondent, on the other hand, asserts

petitioner told Revenue Agent Bank that the insurance was for his
                                        -11-

personal     residence.     In   this    regard,     respondent's        notice    of

deficiency states, in pertinent part:

     Taxpayer is an insurance agent and works for various
     insurance companies as a salesman. Taxpayer stated that
     he had an office in the home. The taxpayer was asked to
     provide substantiation for his expense as well as the
     insurance policy on his home and failed to do so.
     Taxpayer then stated that his expense is for his car but
     failed to bring any records to verify this statement.

      In general, section 274(d) provides that no deduction shall be

allowed as a trade or business expense for any traveling expenses

or with respect to any listed property, as defined in section

280F(d)(4), unless the taxpayer substantiates by adequate records

or   by    sufficient     evidence     corroborating      the   taxpayer's        own

statement    the   business      purpose      of   the   expense.   A    passenger

automobile is a "listed property" within the purview of section

280F(d)(4).

     Petitioner failed to provide the requisite substantiation that

would enable petitioners to deduct the purported insurance expenses

on the automobile allegedly used in connection with petitioner's

insurance business.        Moreover, respondent did allow a deduction

(under the heading "travel expenses", see supra) in the amount of

$2,703 as automobile travel expenses incurred in connection with

petitioner's       insurance      business.        Accordingly,     we      sustain

respondent's    disallowance      of    the    claimed    $1,983    of   insurance

expenses.

      D.    Phone Expenses

     Respondent disallowed the claimed telephone expenses on the
                                    -12-

basis that petitioner failed to provide substantiation for these

expenses.    A substantial portion of the claimed expenses was for

foreign country calls that pertained to the startup of petitioner's

export business.     However, a portion of the telephone expenses was

in connection with petitioner's insurance business.

      Under certain circumstances, if claimed deductions are not

adequately substantiated, we may estimate them, provided we are

convinced that the taxpayer has incurred such expenses and we have

a basis upon which to make an estimate.         Cohan v. Commissioner, 39

F.2d 540 (2d Cir. 1930); Vanicek v. Commissioner, 85           T.C. 731, 743

(1985). Based on the record presented, using our best estimate, and

giving consideration to section 262(b),4 we find, and thus hold,

that petitioners are entitled to a deduction for telephone expenses

in   the   amount   of   $1,500   for   1992.   See,   e.g.,   Velinsky   v.

Commissioner, T.C. Memo. 1996-180.

      E. Commissions Expenses


      4
            SEC. 262.    PERSONAL, LIVING, AND FAMILY EXPENSES.

                 (a) General Rule.--Except as otherwise
            expressly provided in this chapter, no
            deduction shall be allowed for personal,
            living, or family expenses.

                 (b) Treatment of Certain Phone
            Expenses.--For purposes of subsection (a), in
            the case of an individual, any charge
            (including taxes thereon) for basic local
            telephone service with respect to the 1st
            telephone line provided to any residence of
            the taxpayer shall be treated as a personal
            expense.
                                   -13-

     Petitioners claimed $5,184 as commissions expenses. A portion

of this amount represented offices expenses ($1,053), and the

balance represented commissions paid to other insurance agents

($4,131).    In the notice of deficiency, respondent allowed all but

$2,006 of the claimed $5,184.

     Petitioner testified that the disallowed $2,006 represented

payments to Edward Levenson, who obtained an insurance policy that

petitioner    wrote   and   for   which   he   received   a   commission.

Respondent, on brief, concedes that petitioner is entitled to a

deduction in the amount of $1,053 for office expenses and $2,006

for the payments to Mr. Levenson.         Respondent now asserts that

$2,125 should be disallowed as commissions expenses ($5,184 -

($1,053 + $2,006)), claiming petitioner testified that he paid no

other commissions in 1992. Respondent misunderstands petitioner's

testimony; petitioner did not concede any part of the claimed

commissions expenses.

     On the basis of respondent's concession that the $2,006 paid

to Mr. Levenson is deductible, and because that amount was the only

amount challenged in the notice of deficiency with regard to the

claimed $5,184 of commissions expenses, we hold that petitioners

are entitled to a Schedule C deduction for commissions expenses in

the amount of $5,184, as claimed.
                                -14-

Issue 4.   Delinquency Addition to Tax and Accuracy-Related Penalty

     Respondent determined the section 6651(a)(1) addition to tax

for failure to timely file a 1992 income tax return and the section

6662 accuracy-related penalty for negligence.

     Section 6651(a)(1) provides for an addition to tax for failure

to file a timely return.   A taxpayer may avoid the addition to tax

by establishing that the failure to file a timely return was due to

reasonable cause and not willful neglect. Rule 142(a); United

States v. Boyle, 469 U.S. 241, 245-246 (1985).

     Petitioners failed to timely file their 1992 tax return. They

did not present any evidence establishing that their delinquent

filing was due to reasonable cause.    Indeed, the evidence reveals

that they knew that they were required to file income tax returns

but did not do so until contacted by respondent's revenue agent.

     Section 6662 imposes a penalty equal to 20 percent of the

portion of the underpayment that is attributable to negligence. In

order to avoid this penalty, petitioners must prove that they were

not negligent.   Negligence is defined as the failure to exercise

the due care that a reasonable, prudent person would exercise under

similar circumstances.   Zmuda v. Commissioner, 731 F.2d 1417, 1422

(9th Cir. 1984), affg. 79 T.C. 714 (1982); Neely v. Commissioner,

85 T.C. 934, 947 (1985).

     Petitioners failed to exercise the due care that a reasonable

prudent person would have exercised by (1) failing to maintain

adequate books and records, (2) failing to report the $7,220 sales
                                     -15-

award    as   income,   and   (3)   overstating    Schedule   C   deductions.

Accordingly, we sustain respondent's determination that petitioners

are liable for both the section 6651(a)(1) addition to tax and the

section 6662 penalty for 1992.

        To reflect the foregoing,


                                                  Decision will be entered

                                            under Rule 155.
