                       T.C. Memo. 1997-72



                    UNITED STATES TAX COURT



         BRUCE K. REMY AND GAIL E. REMY, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 7266-94.           Filed February 10, 1997.



     Bruce K. Remy, pro se.


     William F. Castor, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION

     WHALEN, Judge:    Respondent determined the following

deficiencies in, and penalties on, petitioners’ income

taxes:
                             - 2 -

                                              Penalty
            Year         Deficiency          Sec. 6662

            1990           $470                 $270
            1991          4,345                1,114
            1992          5,320                1,428


All section references are to the Internal Revenue Code,

as in effect during the years in issue.     We are called upon

to decide three questions:   First, whether petitioners can

deduct the value of certain uncompensated medical services

that Dr. Remy provided to his patients, as an advertising

expense under section 162; second, whether the subject tax

deficiencies should be disallowed on the ground that the

original revenue agent's report contained "gross errors of

fact"; third, whether petitioners are liable for the

accuracy-related penalty under section 6662(a).


                     FINDINGS OF FACT

     Some of the facts have been stipulated by the parties.

The stipulation of facts, the supplemental stipulation of

facts, and the exhibits attached thereto are hereby

incorporated in this opinion.     At the time the subject

petition was filed in this Court, petitioners resided in

the State of Oklahoma.   In this opinion, references to

petitioner are references to Dr. Bruce K. Remy.
                              - 3 -

        Petitioner is a medical doctor.   During the years in

issue, he operated an ambulatory care medical clinic in

Norman, Oklahoma.     As part of his practice, petitioner

consulted with his patients by telephone.      From time to

time, he also telephoned pharmacies to authorize the

refilling of prescriptions on behalf of patients who

requested him to do so.

        Typically, petitioner did not charge his patients and

received no cash or other compensation for these telephone

services.     If petitioner felt that a patient was abusing

this free service, he would either refuse to provide the

service to the patient, or provide the service but ask the

patient to come to his office for an appointment.

        Beginning on September 25, 1991, petitioner kept a log

of his telephone consultations with patients.      Each entry

in the log consisted of the name of the patient, the date

of the call, and a brief description of the nature of the

call.    For the period September 25, 1991, through the end

of 1991, there were approximately 190 entries in the log.

For tax year 1992, there were approximately 860 entries in

the log.

     During the years in issue, petitioners reported income

for Federal income tax purposes on the basis of the cash

receipts and disbursements method of accounting.     Attached
                              - 4 -

to each of petitioners' joint income tax returns for 1990,

1991, and 1992 is a Schedule C, Profit or Loss From

Business, designated "Ambulatory Medical Clinic".    On each

Schedule C, petitioners claimed a deduction for advertising

expenses which included the telephone services described

above.    The advertising deductions claimed on their

Schedules C, and the portion of each deduction attributed

to petitioner's telephone services are as follows:


         Tax       Advertising           Portion for
         Year       Deduction         Telephone Services

         1990        $6,448                $3,328
         1991        16,535                15,600
         1992        18,141                17,169

                     41,124                36,097


     The deductions claimed for telephone services did not

involve an outlay of cash or property by petitioners, but

are based upon the value Dr. Remy ascribed to the

professional services for which he was not compensated.

Petitioner computed the value of the telephone services

deducted in 1990 by estimating the number of telephone

calls he received during the year, and multiplying that

number by $15, a minimum charge for his medical services.

Petitioner computed the value of the telephone services

deducted in 1991 by estimating the number of calls he
                            - 5 -

received before September 25, 1991, and adding the number

of entries in his journal for the period after

September 24, 1991.   He then multiplied that sum by $15,

a minimum charge for his medical services.   Petitioner

computed the value of the telephone services deducted in

1992 by multiplying the number of entries in his log by

$20, a minimum charge for his medical services.   Petitioner

did not include in gross income the value of the uncompen-

sated medical services deducted on his returns for 1990,

1991, or 1992.

     Following his audit of petitioners' income tax returns

for 1990, 1991, and 1992, respondent's revenue agent

proposed adjustments to the deductions claimed by

petitioners for advertising expenses, bad debts, and rent

expense.   The agent mailed a copy of his preliminary report

to petitioners.   In a section of the revenue agent's report

dealing with the adjustments to petitioners' advertising

deductions, the report states as follows:


     FACTS:The [sic] taxpayer is a medical doctor that
     runs an ambulatory (Walk-in) medical clinic. The
     taxpayer is the only doctor in the clinic. The
     taxpayer reports his income on Schedule C of his
     Form 1040. The taxpayer uses the cash method of
     accounting. Under the cash method of accounting,
     the income is reported when received and the
     expenses deducted when paid. It was discovered
     that most of the deduction that the taxpayer had
     for advertising was what the taxpayer called
                            - 6 -

     "goodwill" advertising. The taxpayer stated that
     he did not always charge when patients called in
     for a consultations [sic] on the phone or when
     patients called him to have prescriptions
     refilled. The taxpayer has stated that the
     normal charge for this type of service is $15 to
     $20. The taxpayer had kept a log of calls that
     he received and he deducted for these calls as
     goodwill advertising.

     LAW:Internal [sic] Revenue Code Section 162
     states that there shall be allowed as a deduction
     all the ordinary and necessary expenses paid or
     incurred during the taxable year in carrying on
     any trade or business.

     In Von [sic] Iderstine Co., 16 TCM 790, Dec.
     22,578(M) the court stated that no evidence to
     show any publicity for the petitioner resulted
     from making payment or that any goodwill was
     engendered.

     Taxpayer's Position:The [sic] taxpayer's position
     is that the services that he provided has a
     value. The taxpayer states that cash does not
     have to change hands if the services provided has
     [sic] a clear monetary value. The taxpayer,
     therefore, thinks it is reasonable to consider
     the services having a cash value and being
     deductible as an advertising expense.

     Conclusion:Based [sic] upon the facts and law
     stated above, the taxpayer is not entitled to the
     claimed deduction. The taxpayer is on the cash
     method of accounting. No income has ever been
     reported for the claimed deduction. In addition,
     the taxpayer has not proved that any goodwill was
     engendered. Items are not deductible under IRC
     162.


     Approximately 6 months later, respondent mailed to

petitioners the notice of deficiency that is at issue in

this proceeding.   In the notice of deficiency, respondent
                             - 7 -

determined tax deficiencies and penalties with respect to

the adjustment of petitioners' deductions for advertising,

bad debts, and rent expense.   The following explanation of

respondent's adjustment to petitioners' advertising expense

is provided in the notice:


     The deductions of $6,448.00, $16,535.00 and
     $18,141.00 shown on your 1990, 1991 and 1992
     returns, respectively, as Schedule C advertising
     expense are reduced by $3,329.00, $15,600.00 and
     $17,169.00, respectively, because it has not been
     established that any amounts more than $3,119.00,
     $935.00 and $972.00, respectively, were for
     ordinary and necessary business expenses, or were
     expended for the purpose designated. Therefore,
     your taxable income is increased $3,328.00,
     $15,600.00 and $17,169.00, respectively.


Prior to issuance of the notice of deficiency, petitioners

conceded liability for the portion of the proposed

deficiencies attributable to the bad debts and rent expense

adjustments.   Petitioners did not concede liability for the

accuracy-related penalty under section 6662 with respect to

any of the adjustments.

     Although he is highly educated, petitioner has had

no formal training in tax law.   Since at least 1990,

petitioner has researched income tax issues by reading the

Internal Revenue Code, accompanying regulations, case law,

and other tax materials such as tax guides.   Although

petitioner has never sought formal advice from lawyers,
                             - 8 -

accountants, or other tax professionals, he did

“informally” seek the advice of professionals with whom he

was acquainted.

                            OPINION

Advertising Expenses

     The principal issue in this case is whether

petitioners are entitled to deduct, as an advertising

expense under section 162, the value of the uncompensated

medical services Dr. Remy provided to his patients during

the years in issue.    Section 162 allows an individual to

deduct all ordinary and necessary expenses paid or incurred

during the taxable year in carrying on a trade or business.

Sec. 162(a).   Respondent does not question petitioners'

method of valuing Dr. Remy's telephone services, and does

not seriously question the relationship of those services

to Dr. Remy's trade or business.      Respondent asserts that

the deductions are not allowable because the amounts that

petitioners seek to deduct are not expenditures that

petitioners, cash basis taxpayers, "paid" during any of the

years in issue, as required by section 162(a).      We agree

with respondent.

     We start with the principle that deductions are a

matter of legislative grace and are to be narrowly

construed.   See, e.g., Commissioner v. Jacobson, 336 U.S.
                              - 9 -

28, 49 (1949).    Petitioners bear the burden of proving that

they are entitled to the deductions at issue.      Rule 142(a),

Tax Court Rules of Practice and Procedure; New Colonial Ice

Co. v. Helvering, 292 U.S. 435, 440 (1934).

     Section 162(a) provides in part as follows:


                  SEC. 162(a). In General.--There
             shall be allowed as a deduction all the
             ordinary and necessary expenses paid or
             incurred during the taxable year in
             carrying on any trade or business * * *


     Generally, a cash basis taxpayer is not entitled to

deduct a trade or business expense under section 162(a)

unless the taxpayer has paid the expense during the taxable

year.     Secs. 1.446-1(c)(1)(i), 1.461-1(a)(1), Income Tax

Regs; e.g., Magnon v. Commissioner, 73 T.C. 980, 1001-1002

(1980).    This applies to all trade or business expenses,

including advertising expenses.       E.g., Leone v. Commis-

sioner, T.C. Memo. 1993-51; Madden v. Commissioner, T.C.

Memo. 1989-162.

     The value of labor performed by a taxpayer does not

constitute an amount "paid or incurred", and, for that

reason, a cash basis taxpayer is not entitled to deduct the

value of his or her own labor as a business expense under

section 162(a).     Maniscalco v. Commissioner, 632 F.2d 6,

7-8 (6th Cir. 1980), affg. T.C. Memo. 1978-274; Grant v.
                          - 10 -

Commissioner, 84 T.C. 809, 819-820 (1985), affd. without

published opinion 800 F.2d 260 (4th Cir. 1986); Rink v.

Commissioner, 51 T.C. 746, 753 (1969); Fisher v. Commis-

sioner, T.C. Memo. 1986-141; cf. Hutcheson v. Commissioner,

17 T.C. 14, 19 (1951); Walter v. Commissioner, T.C. Memo.

1979-132; Jeppsen v. Commissioner, T.C. Memo. 1978-343;

Bers v. Commissioner, T.C. Memo. 1976-263; Butrick v.

Commissioner, T.C. Memo. 1972-59; Escofil v. Commissioner,

T.C. Memo. 1971-131, affd. 464 F.2d 358 (3d Cir. 1972).

To hold otherwise would be to allow a business deduction

for unpaid compensation which was never reported as income.

See Hutcheson v. Commissioner, supra at 19; see also

Stengel v. Commissioner, T.C. Memo. 1992-570, affd. without

published opinion 996 F.2d 1227 (9th Cir. 1993), in which

the Court stated:


          The law is clear regarding a failure to
     realize anticipated future income. Such failure
     is not a loss contemplated by section 165. As
     the Supreme Court succinctly stated in Hort v.
     Commissioner, 313 U.S. 28, 32-33 (1941), "Nothing
     in section 23(e) [currently at section 165]
     indicates that Congress intended to allow
     petitioner to reduce ordinary income actually
     received and reported by the amount of income he
     failed to realize." * * *


The same is true of section 162.
                           - 11 -

     Petitioners note that section 162 "does not define

what constitutes an expense", and argue that the term

"expense" should be "the converse of income".    Petitioners

further note that under section 61 gross income means all

income "whether received in the form of money, property,

or services."   Therefore, according to petitioners, a

deductible expense should include any expenditure made

"in the form of money, property, or services."

     Petitioners support their contention that the value of

services is deductible under section 162 by noting that

under section 132, an employee is not entitled to exclude

from gross income a fringe benefit consisting of a service

provided by his or her employer unless the fringe benefit

qualifies as a "no-additional-cost service", as defined by

section 132(b).   Petitioners reason that the employee could

not receive income in the form of services "unless the

employer is incurring an equal expense in the form of the

services * * * rendered to the employee".

     Petitioners attempt to further support their

contention that the value of services is deductible under

section 162 by noting that section 162(a)(1) allows the

deduction of "a reasonable allowance for salaries or other

compensation for personal services actually rendered".

Petitioners argue that "the term 'other compensation'
                           - 12 -

appears to include non-cash expenditures for fringe

benefits in the form of goods or services."   In support of

this assertion, petitioners cite Wright v. Commissioner,

T.C. Memo. 1992-60, in which the Court permitted the

operator of a barter exchange to deduct under section

162(a) the value of "trade units", the medium of exchange

for transactions between members of the barter exchange,

that the taxpayer repaid to the exchange to correct

deficits created by other members.    Petitioners also cite

Sullivan v. Commissioner, T.C. Memo. 1982-150, in which the

Court allowed a service station operator to deduct the cost

of beer that he offered to his customers free of charge

while their vehicles were being filled with gasoline or

serviced.   Finally, petitioners cite Newark Morning Ledger

Co. v. United States, 507 U.S. 546 (1993), which

petitioners argue establishes "an important conceptual

landmark which, in this instance, would allow a basis for

the valuation and favorable tax treatment of legitimate

services provided by a business owner for the benefit of

his customers to engender good will, under the advertising

expenses expressly allowable under Reg. section 1.162-1."

     Petitioners fail to perceive that section 162 limits

the expenses that a cash basis taxpayer can deduct to those

which are "paid" during the year.    Petitioners also fail to
                            - 13 -

perceive that, in rendering professional services, Dr. Remy

has not "paid" an expense for purposes of section 162.    As

we noted in Rink v. Commissioner, supra at 753:


     Just as "imputed income" arising from the bene-
     fit a taxpayer's own services yield to him is
     not taxable under our system of taxation,
     neither is the "imputed expense" arising out
     of his exertions a proper deduction from income.
     Labor performed by a taxpayer does not constitute
     an amount "paid or incurred" by him, and conse-
     quently, cannot be deducted by him under section
     162 * * *. [Citations omitted.]


None of the cases cited by petitioners holds to the

contrary.    In two of the cases, the expenditures that were

held to qualify as business expenses under section 162

consisted of cash or property and did not involve unpaid

services provided by the taxpayer.    In Wright v. Commis-

sioner, supra the taxpayer was permitted to deduct the

value of "trade units" that he had repaid to the exchange.

In Sullivan v. Commissioner, supra the taxpayer was

permitted to deduct the cost of the beer he gave to his

customers.    In the instant case, on the other hand,

petitioner made no expenditure of cash or property and,

thus, no expenditure for which a business deduction is

allowable under section 162.

     The third case cited by petitioners, Newark Morning

Ledger Co. v. United States, supra, does not involve a
                            - 14 -

deduction of the value of services rendered by a cash basis

taxpayer.   In that case, the Supreme Court held that a

newspaper publisher had proven that a list of "paid

subscribers" constituted an intangible asset with an

ascertainable value and a limited useful life, the duration

of which could be ascertained with reasonable accuracy,

and, thus, qualified for the depreciation allowance under

section 167.    The case does not support petitioner's

assertion that the value of professional services rendered

constitutes a deductible advertisement expense.

     In light of the forgoing, we hold that the value of

the telephone services rendered by petitioner was not an

expense that was “paid or incurred” during any of the years

in issue and is not deductible under section 162.

Therefore, we sustain respondent's determination that

petitioners are not allowed a deduction for the value of

the time Dr. Remy spent giving free telephone services to

his patients.

Validity of Notice of Deficiency

     Petitioners also argue that the Court should disallow

the subject tax deficiencies on the ground that the revenue

agent's report, upon which the notice of deficiency is

based, contains "gross errors of fact".    In support of

this argument, petitioners cite Bruce & Human Drug Co.
                           - 15 -

v. Commissioner, 1 B.T.A. 342 (1925), a case involving

income and profits taxes for the years 1918 to 1920.

In that case, the Board of Tax Appeals found that the

Commissioner's revenue agent had not properly computed the

taxpayer's net income.   The Board noted that the revenue

agent had arrived at the taxpayer's net income "by adding

certain alleged omissions of income to the net income

returned by the taxpayer on his original return, without a

verification of the entire net income, either by an

examination of all the income and expenses, or by a proof

of the opening and closing balance sheets."   Id. at 346.

At the same time, the Board found that the taxpayer's

proof, consisting principally of an "audit" of the

taxpayer's books by an independent certified public

accountant, could not prove the correctness of the

taxpayer's net income.   Nevertheless, the Board found "from

the entire record that the proposed deficiency [was] not

well founded" and   "disallowed" the deficiency.   Id.

     Petitioners' argument focuses on alleged "gross

errors of fact contained in the original revenue examiner's

report", and petitioners ask the Court "to disallow the

Commissioner's contention that a deficiency existed in the

first place".   In particular, petitioners assert that "the

revenue examiner was unable to cite any statute which would
                           - 16 -

serve to prohibit or disallow the petitioner's claimed

deduction for goodwill advertising".

     They also assert that the agent’s report relies on a

case, Van Iderstine Co. v. Commissioner, T.C. Memo. 1957-

177, revd. 261 F.2d 211 (2d Cir. 1958), which does not

apply here and was not relied on by respondent at trial.

Finally, they assert that the revenue agent’s report

"incorrectly stated that 'no income has ever been reported

for the claimed deduction' when, in fact, the majority of

the petitioner's income was in the form of professional

fees received within the same business context as the

advertising expenditures claimed by the petitioner."

     We reject petitioners' argument on the basis of the

well-established rule that the Court will not look behind

a notice of deficiency to review the Commissioner's

administrative consideration of a case.   E.g., Greenberg's

Express, Inc. v. Commissioner, 62 T.C. 324, 327 (1974).

The rationale for this rule is that a trial before this

Court is a proceeding de novo, and our determination of a

taxpayer's tax liability must be based on the merits of the

case and not on any previous record developed at the

administrative level.   Id. at 328.

     Furthermore, we disagree with petitioners that the

three particulars enumerated in their post-trial brief
                            - 17 -

demonstrate "gross errors of fact" in the revenue agent's

report.    The first two particulars, i.e., that the agent

failed to cite any statute that would disallow the claimed

deduction, and that the agent cited Van Iderstine Co. v.

Commissioner, supra, have nothing to do with the facts of

the case.    The last particular, consisting of the statement

in the revenue agent's report that "no income has ever been

reported for the claimed deduction", deals with a fact, but

one which is true.    As mentioned above, we found that

petitioners deducted the value of Dr. Remy's professional

time in performing telephone services for his patients but

did not include that amount in their gross income.    Thus,

it is clear that no income has ever been reported for the

claimed deduction.


Accuracy-Related Penalty

     Respondent determined that petitioners are liable for

an accuracy-related penalty under section 6662(a) for each

of the years in issue.    Section 6662(a) imposes a penalty

equal to 20 percent of the portion of the underpayment of

tax which is attributable to one or more of five types of

errors specified in section 6662(b) including:


     (1)    Negligence or disregard of rules or
            regulations.
                              - 18 -

     (2)   Any substantial understatement of
           income tax.


Respondent determined that the entire underpayment of tax

in 1990 is attributable to negligence or disregard of rules

and regulations.    Respondent further determined that the

entire underpayments of tax in 1991 and 1992 are

attributable to substantial understatements of income tax,

or, alternatively, are due to negligence or disregard of

rules and regulations.

     For purposes of section 6662, the term "negligence"

includes any failure to make a reasonable attempt to comply

with the provisions of the tax code, and the term

"disregard" includes any careless, reckless, or intentional

disregard.    Sec. 6662(c).   For purposes of section 6662,

the phrase "substantial understatement of income tax" is

defined by section 6662(d)(1) as follows:


          (A) In general.--For purposes of this sec-
     tion, there is a substantial understatement of
     income tax for any taxable year if the amount of
     the understatement for the taxable year exceeds
     the greater of--

             (i) 10 percent of the tax required to
             be shown on the return for the taxable
             year, or

             (ii) $5,000.
                           - 19 -

The amount of an understatement is reduced by the portion

thereof attributable to the tax treatment of any item for

which there is or was substantial authority, or of any item

with respect to which the relevant facts are adequately

disclosed in the return or on a statement attached to the

return.   Sec. 6662(d)(2)(B).

     Petitioners assert that they meet the requirements of

section 6664(c), and that no penalty can be imposed under

section 6662(a).   Section 6664(c)(1) provides:


     No penalty shall be imposed under this part with
     respect to any portion of an underpayment if it
     is shown that there was a reasonable cause for
     such portion and that the taxpayer acted in good
     faith with respect to such portion.


The regulations promulgated under section 6664(c)(1)

provide as follows:


     The determination of whether a taxpayer acted
     with reasonable cause and in good faith is made
     on a case-by-case basis, taking into account all
     pertinent facts and circumstances. The most
     important factor is the extent of the taxpayer's
     effort to assess the taxpayer's proper tax
     liability. Circumstances that may indicate
     reasonable cause and good faith include an
     honest misunderstanding of fact or law that is
     reasonable in light of the experience, knowledge
     and education of the taxpayer. [Sec. 1.6664-
     4(b)(1), Income Tax Regs.]
                           - 20 -

Petitioners bear the burden of showing that there was

reasonable cause for, and that they acted in good faith

with respect to, a portion of an underpayment.    Rule 142.

     As to the portion of the penalty determined by

respondent with respect to the adjustment of petitioners'

deduction of advertising expenses, petitioners make the

following argument:


          Since the petitioner has demonstrated to
     the court that he did not engage in careless,
     reckless, or intentional disregard of any
     existing statute, and since the respondent has
     been unable to prove that the petitioner acted
     in any manner other than in good faith, the
     petitioner submits that the penalties should
     not apply.


     Based upon Dr. Remy's testimony, it is evident that he

attempted to research the tax law to find authority for his

position that the amount of his noncompensated telephone

services is deductible.   It is also evident that he took

steps to accurately document the extent of his telephone

services by maintaining a log.   However, this is not enough

to be relieved of the accuracy-related penalty.    Section

6664(c)(1) requires "a reasonable cause".   In this case,

petitioners have not shown that the underpayment

attributable to the deductions in question was due to

reasonable cause.   To the contrary, we cannot find
                            - 21 -

petitioners' position reasonable in light of the weight

of authority against that position.    Cf. United States v.

Fitzsimmons, 712 F.2d 1196 (7th Cir. 1983), where a

taxpayer's conviction for willfully and knowingly making

and subscribing tax returns that he did not believe to be

true and correct, in violation of section 7206(1), was

predicated on the fact that the taxpayer, a dentist,

reduced his gross receipts by the value of certain free

services to his patients.   Accordingly, the portion of the

penalty attributable to petitioners' deduction of

advertising expenses is sustained.

     We find that petitioners are liable also for the

portion of the penalty determined by respondent with

respect to the adjustments conceded by petitioners; i.e.,

the bad debts and rent expense adjustments.     The burden

is on petitioners to prove that a penalty does not apply.

Reily v. Commissioner, 53 T.C. 8, 14 (1969).     Petitioners

have not met their burden of proof.     They conceded the bad

debts and rent expense adjustments prior to the issuance of

the notice of deficiency, and they introduced no evidence

as to those adjustments at trial.     We have no basis in the

record of this case to overturn respondent's determination

that petitioners are liable for the penalty under section

6662(a) with respect to the adjustment of petitioners' bad
                          - 22 -

debts and rent expense deductions.   Accordingly, we hereby

sustain respondent's determination of petitioners'

liability for the penalty under section 6662(a) on the

portion of the underpayment attributable to those

adjustments.

     In light of the foregoing,


                                  Decision will be entered

                           for respondent.
