                  T.C. Memo. 2001-226



                UNITED STATES TAX COURT



     EFRAIN J. AND JOSEFINA XUNCAX, Petitioners v.
      COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 3380-00.                     Filed August 15, 2001.



     Respondent determined a deficiency for
petitioners’ 1996 taxable year based primarily on the
disallowance of amounts claimed for cost of goods sold
and business expenses on petitioners’ Schedule C,
Profit or Loss from Business.

     Held: Petitioners are liable for a deficiency as
redetermined herein.

     Held, further, petitioners are liable for the sec.
6662(a), I.R.C., accuracy-related penalty.



Efrain J. and Josefina Xuncax, pro sese.

Jonathan H. Sloat, for respondent.
                                 - 2 -

               MEMORANDUM FINDINGS OF FACT AND OPINION


       NIMS, Judge:   Respondent determined a Federal income tax

deficiency for petitioners’ 1996 taxable year in the amount of

$71,091.00.    Respondent also determined an accuracy-related

penalty of $14,218.20 for 1996, pursuant to section 6662(a).

       After a concession by respondent, the issues for decision

are:

       (1) Whether petitioners are entitled to offset gross profits

reported on their 1996 Schedule C, Profit or Loss from Business,

by claimed cost of goods sold in an amount in excess of that

allowed by respondent;

       (2) whether petitioners are entitled to Schedule C business

expense deductions in excess of the amounts allowed by

respondent; and

       (3) whether petitioners are liable for the section 6662

accuracy-related penalty.

       Additional adjustments made by respondent to petitioners’

exemptions, itemized deductions, earned income credit, and self-

employment tax are computational in nature and will be resolved

by our holdings on the foregoing issues.

       Unless otherwise indicated, all section references are to

sections of the Internal Revenue Code in effect for the year at

issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure.
                                - 3 -

                          FINDINGS OF FACT

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

The stipulations of the parties, with accompanying exhibits, are

incorporated herein by this reference.    At the time the petition

was filed in this case, petitioners resided in Los Angeles,

California.

       During 1996, petitioners operated a proprietorship under the

name of EJX Contractor (EJX).    EJX was engaged in the business of

sewing materials provided by a contracting manufacturer into a

finished product.    All materials necessary to complete the items,

with the exception of thread, were supplied by the manufacturer.

Through such arrangements, EJX was principally involved in the

sewing of jeans and shorts.    EJX’s day-to-day operations during

the year at issue were managed by Miguel X. Mendez, petitioners’

son.

       On the Schedule C attached to their 1996 Federal income tax

return, petitioners reported gross receipts from EJX of $485,009,

cost of goods sold of $274,109, and total expenses of $183,427.

Accordingly, EJX was reflected as having earned a net profit of

$27,473.    Such receipts and expenditures were computed using the

cash method of accounting.

       As a result of the subsequent examination of petitioners’

return, respondent issued a notice of deficiency making

adjustments to the foregoing Schedule C amounts.    Respondent
                                 - 4 -

disallowed in full or in part amounts claimed by petitioners for

cost of goods sold and business expense deductions, as follows:

            Item           Amount Claimed on      Amount Allowed Per
                                 Return          Notice of Deficiency
                                 1
Cost of Goods Sold                   $274,109             $137,055
Advertising                             1,329                       0
Car & Truck                             8,665                       0
Commissions                             6,786                       0
Depreciation                           13,352                  13,352
Insurance                               4,967                       0
Legal & Professional                    8,012                       0
Office Expense                          4,625                       0
Rent                                   31,200                  24,000
Repairs                                29,652                       0
Supplies                               46,712                       0
Taxes & Licenses                          803                       0
Travel                                  8,623                       0
Meals                                   2,006                       0
Utilities                               9,974                       0
Wages                                   6,721                  78,100
           TOTAL                     $457,536             $252,507

       1
         Petitioners’ return shows this figure as comprising
       $50,925 for “Cost of labor” and $223,184 for “Other
       costs”.

       Additionally, since issuance of the notice of deficiency,

respondent has conceded that petitioners are entitled to deduct

as a Schedule C legal and professional expense $725 paid for

bookkeeping services.
                               - 5 -

     The allowances described above were based upon invoices and

receipts provided to respondent prior to trial and made a part of

the record in this case.   At trial, Mr. Mendez spoke on behalf of

his parents (who apparently have minimal command of English).   He

testified that EJX’s business deteriorated shortly after the year

at issue and closed in the fall of 1997.   He also indicated that

no business records were retained and conceded that petitioners

could offer no further substantiation for their claimed costs and

expenses.   In addition, he explained that efforts to locate the

bookkeeper who had prepared EJX’s business records as well as

petitioners’ 1996 return had been unavailing.   In this

connection, the colloquy set forth below exemplifies Mr. Mendez’s

testimony on these matters:

          THE COURT: Now, why don’t you tell the Court
     anything you want to state in regard to your family’s
     tax problems.

          THE WITNESS: Yeah. The only thing I can say is
     that we had--we were in this business quite a long time
     and we were doing good, since my dad went to--you know,
     like he got sick and almost everything of the business,
     it went down like, you know, no--there were no--there
     were my father not working. So the business, it was
     not good.

          So what I can tell is that I wish I can have all
     the proofs we used to--we had for all the other years,
     which is--you know, we used to do good things. You
     know, keep the files, but since we decide not to work
     with it anymore.

          So we just--actually my dad--we don’t have no
     proofs. We just we cannot come with that proof.
                               - 6 -

          The only thing I can--the thing only I can say is
     that if we have some proof--we did our best to look for
     it. We--even we went to our bookkeeper who used to
     take care of our business, but unfortunately he’s not
     longer in that place. So we couldn’t get some--you
     know, like some proofs that we did, you know.

          THE COURT:   Who made out the income tax return--

          THE WITNESS:   That’s our bookkeeper.


     Aside from Mr. Mendez’s testimony, which we note was

generally imprecise and difficult to follow, the only evidence

offered by petitioners at trial was a document dated March 19,

2001, that stated:

          I Miguel X. Mendez and Efrain J. Xuncax declare
     that although we don’t have any further proves of 1996
     income tax, we affirm that in the year 1996 we
     approximately paid 15 to 20 employees in cash for their
     weekly labor. We came to an agreement with our
     employees that by the end of the year they would
     receive from us a form 1099. With this purpose it gave
     them an opportunity to file their income tax for the
     following year. The amount that this employees
     received yearly was approximately ten thousands
     dollars. However, we don’t have much proves of these
     valuable documents therefore, we have tried to locate
     our bookkeeper for further assistant but we apparently
     found out that he was no longer in the same business.
     We write this testimony in the hope that this matter
     would be more explicable.

     At the close of the trial, the Court indicated to

petitioners that they would be afforded an opportunity to file a

posttrial brief in support of their position.     Petitioners have

chosen not to do so.
                                 - 7 -

                                OPINION

I.   Burden of Proof

     We begin with a threshold observation regarding burden of

proof.   As a general rule, determinations by respondent are

presumed correct, and taxpayers bear the burden of proving

otherwise.   Rule 142(a).   Section 7491, however, may shift the

burden to the Commissioner in certain circumstances.     Section

7491 is applicable to court proceedings that arise in connection

with examinations commencing after July 22, 1998, and reads in

pertinent part:

     SEC. 7491.    BURDEN OF PROOF.

          (a) Burden Shifts Where Taxpayer Produces Credible
     Evidence.--

                (1) General rule.--If, in any court
           proceeding, a taxpayer introduces credible
           evidence with respect to any factual issue
           relevant to ascertaining the liability of the
           taxpayer for any tax imposed by subtitle A or B,
           the Secretary shall have the burden of proof with
           respect to such issue.

                (2) Limitations.--Paragraph (1) shall apply
           with respect to an issue only if--

                       (A) the taxpayer has complied with the
                  requirements under this title to substantiate
                  any item;

                       (B) the taxpayer has maintained all
                  records required under this title and has
                  cooperated with reasonable requests by the
                  Secretary for witnesses, information,
                  documents, meetings, and interviews; * * *

                       *    *    *       *   *   *   *
                                - 8 -

          (c) Penalties.--Notwithstanding any other
     provision of this title, the Secretary shall have the
     burden of production in any court proceeding with
     respect to the liability of any individual for any
     penalty, addition to tax, or additional amount imposed
     by this title. [See also Internal Revenue Service
     Restructuring & Reform Act of 1998, Pub. L. 105-206,
     sec. 3001(c), 112 Stat. 685, 727, regarding effective
     date.]

     Although the record in this case does not reveal when the

examination of petitioners’ 1996 return began, respondent asserts

that the burden is not placed on him under section 7491(a) with

respect to the income adjustments at issue and that respondent

has met his burden of production under section 7491(c) with

respect to the penalties.   We agree.

     As regards the adjustments to cost of goods sold and

business expenses, and as further explained below, petitioners

have failed to offer substantiation for and/or maintain adequate

records concerning the disallowed amounts.   Hence, the

prerequisites of section 7491(a)(2) for placing the burden on

respondent as to these items have not been met.   See also Higbee

v. Commissioner, 116 T.C. 438, 441 (2001); Blodgett v.

Commissioner, T.C. Memo. 2001-147; H. Conf. Rept. 105-599, at 241

(1998), 1998-3 C.B. 747, 995.

     With respect to the accuracy-related penalty, the

Commissioner satisfies the section 7491(c) burden of production

by “[coming] forward with sufficient evidence indicating that it

is appropriate to impose the relevant penalty” but “need not
                                 - 9 -

introduce evidence regarding reasonable cause, substantial

authority, or similar provisions.”       Higbee v. Commissioner, supra

at 446.   Rather, “it is the taxpayer’s responsibility to raise

those issues.”    Id.   Because, as will be more fully detailed

infra, respondent here has introduced sufficient evidence to

render the section 6662(a) penalty at least facially applicable,

the burden rests on petitioners to show their entitlement to an

exception therefrom.

II.   Adjustments to Income

      Computation of the income of a Schedule C business takes

into account both cost of goods sold and other business expenses.

Cost of goods sold is an offset subtracted from gross receipts in

determining gross income.     Sec. 1.61-3(a), Income Tax Regs.

Accordingly, such costs are not treated as deductions and are not

subject to the limitations on deductions contained in sections

162 and 274.     Metra Chem Corp. v. Commissioner, 88 T.C. 654, 661

(1987).   However, any amount claimed as cost of goods sold must

be substantiated, and taxpayers are required to maintain records

sufficient for this purpose.     Sec. 6001; Newman v. Commissioner,

T.C. Memo. 2000-345; Wright v. Commissioner, T.C. Memo. 1993-27;

sec. 1.6001-1(a), Income Tax Regs.

      Once the gross income of a business has been calculated,

business expense deductions are subtracted in determining net

income.   Section 162(a) allows a deduction for “all the ordinary
                              - 10 -

and necessary expenses paid or incurred during the taxable year

in carrying on any trade or business”.   Yet as with cost of goods

sold, amounts deducted must be substantiated, and records

sufficient to establish such deductions must be maintained by the

taxpayer.   Sec. 6001; Hradesky v. Commissioner, 65 T.C. 87, 89-90

(1975), affd. 540 F.2d 821 (5th Cir. 1976); sec. 1.6001-1(a),

Income Tax Regs.

     When a taxpayer adequately establishes that he or she paid

or incurred a deductible expense but does not establish the

precise amount, we may in some circumstances estimate the

allowable deduction, bearing heavily against the taxpayer whose

inexactitude is of his or her own making.   Cohan v. Commissioner,

39 F.2d 540, 543-544 (2d Cir. 1930).   There must, however, be

sufficient evidence in the record to provide a basis upon which

an estimate may be made and to permit us to conclude that a

deductible expense was incurred in at least the amount allowed.

Williams v. United States, 245 F.2d 559, 560 (5th Cir. 1957);

Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985).

     Furthermore, business expenses described in section 274 are

subject to rules of substantiation which supersede the doctrine

of Cohan v. Commissioner, supra.   Sanford v. Commissioner, 50

T.C. 823, 827-828 (1968), affd. 412 F.2d 201 (2d Cir. 1969); sec.

1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov.

6, 1985).   Section 274 provides that no deduction shall be
                                 - 11 -

allowed for, among other things, traveling expenses,

entertainment expenses, meal expenses, and expenses with respect

to listed property (as defined in section 280F(d)(4) and

including passenger automobiles) “unless the taxpayer

substantiates by adequate records or by sufficient evidence

corroborating the taxpayer’s own statement”:      (1) The amount of

the expenditure or use; (2) the time and place of the expenditure

or use; (3) the business purpose of the expenditure or use; and

(4) in the case of entertainment, the business relationship to

the taxpayer of the persons entertained.      Sec. 274(d).

     Applying the foregoing principles to the costs and

expenditures reported on petitioners’ 1996 return, we consider

whether petitioners are entitled to amounts in excess of those

allowed by respondent.

     A.   Cost of Goods Sold

     Petitioners claimed cost of goods sold totaling $274,109, of

which $50,925 was designated as cost of labor and $223,184 was

labeled as “Other costs”.      In support of these amounts,

petitioners provided respondent with payroll invoices and with a

collection of receipts and invoices that seem to relate primarily

to purchases of thread.   Respondent aggregated all of

petitioners’ substantiated compensation-related expenses as

deductible wages, discussed further below, and additionally

allowed petitioners cost of goods sold in the amount of $137,055,
                                - 12 -

half of the figure claimed.   Since the receipts and invoices

which supposedly substantiate petitioners’ “Other costs” total

only $5,476, we conclude that they have failed to prove their

entitlement to cost of goods sold in excess of what already

appears to be a generous allowance by respondent.

     B. Wages Expense

     On their Schedule C, petitioners designated $50,925 as cost

of labor and $6,721 as wages expense.      These amounts add to a

total of $57,646 for compensation-related expenditures.      During

examination, petitioners provided payroll invoices and receipts

for 1996 totaling $55,805.33.    Respondent allowed as a deduction

wages expense of $78,100.   Again, respondent would appear to have

been generous.   Furthermore, to the extent that certain portions

of Mr. Mendez’s testimony and the written statement offered by

petitioners at trial can be interpreted to mean that additional

cash payments were made to employees, such representations are

insufficient to support a further deduction.

     First, the record is entirely devoid of anything which could

corroborate the self-serving averments that cash payments were in

fact made during the year at issue.      Second, even if we were

willing to accept that cash had been remitted, the record

provides no basis for a reasonable estimate of the deductible

amount.   The oral testimony contains no numerical information

whatsoever, as to either the number or the amount of payments,
                                - 13 -

and the written statement is both ambiguous and so blatantly

conjectural as to be almost useless for estimation purposes.       The

document states that EJX “approximately paid 15 to 20 employees

in cash” and that “The amount that this employees received yearly

was approximately ten thousands dollars.”     Hence, at minimum it

is unclear whether 15 to 20 employees received $10,000 each or

whether 15 to 20 employees received $10,000 in the aggregate.       If

the former, we are doubtful of the statement’s veracity.     Wages

and labor costs, both as reported on the 1996 return and as

substantiated, total less than $60,000.     It thus seems highly

unlikely that additional employee payments of $150,000 to

$200,000 were made through less conventional channels and were

mistakenly omitted from petitioners’ return.     On the other hand,

if the latter interpretation should hold sway, we note that

respondent’s generosity already allows for a deduction of more

than $20,000 beyond the substantiated amount.     Thus, under any

interpretation, petitioners’ assertions fall short of showing

their entitlement to further wages expense deductions.

     C.    Rent

     Rent expense of $31,200 was claimed on petitioners’ Schedule

C.   The information provided to respondent on this item consisted

of rental receipts for the 1995, rather than the 1996, taxable

year.     The invoice for December of 1995 shows monthly rent of

$1,750.     Respondent allowed rent expense for 1996 at a rate of
                                - 14 -

$2,000 per month, for a total of $24,000.    Having no basis upon

which to conclude that greater amounts were paid, we sustain

respondent on this issue.

     D.    Payments Due on Account of Violations

     The record contains documentation relating to amounts

assessed by local, State, and Federal agencies on account of

various statutory and regulatory violations.       Although it is not

clear whether petitioners deducted these amounts on their return

and, if so, under what classification of expense, we assume that

inclusion of the documents in the record is based on petitioners’

belief that they support a deduction.

     At the outset, we emphasize that section 162(f) explicitly

provides that no deduction shall be allowed “for any fine or

similar penalty paid to a government for the violation of any

law.”     Accordingly, to the extent that the aforementioned amounts

are of a type within the purview of section 162(f), as the

majority would appear clearly to be, payment thereof is

nondeductible in any event.    However, for the sake of

completeness, we deal briefly with additional reasons why the

documentation offered fails to support increased deductions.

     First, the evidence includes bills from the Los Angeles

Police Department for amounts imposed due to violations of

section 103.206 of the Los Angeles Municipal Code “for excessive

false alarms without the required alarm permit”.      Petitioners
                              - 15 -

were charged $80 per occurrence for false alarms on February 1,1

May 12, June 28, and August 28, 1996.   The record also contains

delinquent status notices dated November 5 and December 3, 1996,

concerning the May and the August alarms, respectively.   The

bills and notices warn that operating an alarm system without a

permit is a misdemeanor.   Thus, additional impediments beyond

section 162(f) are present on these facts.   The delinquency

notices call into question whether at least some of the charges

were paid in 1996, so as to be deductible by a cash basis

enterprise in that year.

     Second, petitioners provided a “Garment Penalty Assessment

Order” from the State of California Department of Industrial

Relations, Division of Labor Standards Enforcement, for a

violation of section 2678 of the California Labor Code.   Cal.

Lab. Code sec. 2678 (West 1989 & Supp. 2001).   The assessment was

issued on October 2, 1996, and the stated grounds involve a

failure to maintain accurate records.   However, the evidence also

includes a letter from the agency dated April 18, 1997, stating

that the penalty had not been paid as of that date.   Petitioners

therefore are entitled to no deduction in 1996.




     1
        Although the pertinent stipulation references Feb. 2,
1996, as the date of the alarm, the bill specifies an alarm date
of “02/01/96”. The minor discrepancy is immaterial for our
purposes.
                               - 16 -

       Third, the record contains a “Citation and Notification of

Penalty” from the State of California Department of Industrial

Relations, Division of Occupational Safety and Health, for

violations of the California Labor Code.    In this notice of

October 2, 1996, the agency cites multiple deficiencies in the

EJX facility and working environment.    Yet the record is again

devoid of any proof of payment.    Given that another State

assessment issued the same date and discussed above remained

unpaid in 1997, we are unwilling to assume that this penalty was

paid during 1996.   Petitioners have not substantiated an

expenditure.

     Fourth, the evidence includes an agreement between EJX and

the U.S. Department of Labor settling alleged violations of the

Fair Labor Standards Act.    Therein, the EJX agreed “to pay back

wages” of $3,557.   Additionally, copies of receipts reflecting

payments to the Department of Labor totaling $3,557 have been

made a part of the record.    Nonetheless, even if this settlement

is more appropriately viewed as a deductible wages expense,

rather than a nondeductible penalty, no further deduction is in

order here.    Once again, respondent’s allowance for wages is

large enough to cover this additional amount.

     E.   License

     Petitioners claimed on their Schedule C $803 for taxes and

licenses.   Respondent disallowed this expense in full.   However,
                              - 17 -

the record contains a garment manufacturing license fee invoice

from the County of Los Angeles for $323.75.   The invoice recites

that unless payment is received before December 15, 1996, legal

proceedings will be instituted.   Handwritten on the invoice is

“pagado con check”, which Mr. Mendez testified he wrote to

signify that the fee was paid by check.   Given this notation and

the logical appeal of Mr. Mendez’s testimony that the business

would not have been able to continue without the license, we are

satisfied that EJX did in fact remit the referenced fee in 1996.

Petitioners are entitled to a deduction for licenses in the

amount of $323.75.

     F.   Advertising

     Petitioners’ Schedule C reflects a deduction for advertising

of $1,329, all of which was disallowed by respondent.   The sole

item in the record which would appear to be traceable to an

advertising expenditure is an invoice from Rick Swinger

Photography for “studio fashion photography with model and 6

roles color film shot”.   The balance due is shown as $950.

Nonetheless, there are again two barriers to permitting a

deduction based upon this document.    First, as with many of the

invoices previously mentioned, the record is barren of any

evidence of actual payment.   Not even a notation on the bill

exists to give rise to an inference in petitioners’ favor.
                                 - 18 -

Second, the invoice is made out to “24 Karat Gold Jean Co.”    When

questioned about this document at trial, Mr. Mendez explained:

          THE WITNESS: This--there were a man came to my
     shop and asked me if I could sew his garment. And
     somehow he start talking about, you know, our business
     to start because sewing was to--it was no good anymore.

          So we tried to do like partnership or so, like I
     was wanting to sew the clothes that he--our products to
     start our own business.

          And we were going to call it 24 Karat Gold Jeans
     or so, but we never get to that.

          MR. SLOAT: So whose business--was that a
     partnership between you and this other person?

           THE WITNESS:   Yes.

     Because this testimony would seem to confirm that the

photography charges were incurred by a business entity other than

EJX (namely, a partnership between petitioners’ son and an

unidentified man), we must conclude that the amount cannot be

deducted on petitioners’ Schedule C.

     G.   Legal and Professional Services

     As previously indicated, respondent has conceded that

petitioners are entitled to include on their Schedule C $725 for

legal and professional services.     This position is based upon an

invoice and receipt reflecting payment for bookkeeping services.

We accept respondent’s concession.
                                - 19 -

       H.   Other Expenses

       With respect to the remaining expenses claimed on

petitioners’ Schedule C and disallowed by respondent, we hold

that petitioners have failed to substantiate these deductions.

The only other evidence in the record consists of miscellaneous

receipts, many of which provide no information regarding the

subject of the underlying transaction or the parties thereto.

Many others are from restaurants (e.g., McDonald’s, Taco Bell,

Sizzler), gas stations, and grocery stores.    A significant

portion are obviously for nondeductible personal expenditures.

Moreover, to the extent that they might relate to the claimed

travel, meal, and vehicle expenses, the receipts fall far short

of the strict substantiation requirements of section 274.      We

sustain respondent’s position as to all remaining expenses not

previously addressed.

III.    Accuracy-Related Penalty

       Subsection (a) of section 6662 imposes an accuracy-related

penalty in the amount of 20 percent of any underpayment that is

attributable to causes specified in subsection (b).    Subsection

(b) of section 6662 then provides that among the causes

justifying imposition of the penalty are:    (1) Negligence or

disregard of rules or regulations and (2) any substantial

understatement of income tax.
                                - 20 -

     “Negligence” is defined in section 6662(c) as “any failure

to make a reasonable attempt to comply with the provisions of

this title,” and “disregard” as “any careless, reckless, or

intentional disregard.”    Case law similarly states that

“‘Negligence is a lack of due care or the failure to do what a

reasonable and ordinarily prudent person would do under the

circumstances.’”     Freytag v. Commissioner, 89 T.C. 849, 887

(1987) (quoting Marcello v. Commissioner, 380 F.2d 499, 506 (5th

Cir. 1967), affg. on this issue 43 T.C. 168 (1964) and T.C. Memo.

1964-299), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S.

868 (1991).   Pursuant to regulations, “‘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.

     A “substantial understatement” is declared by section

6662(d)(1) to exist where the amount of the understatement

exceeds the greater of 10 percent of the tax required to be shown

on the return for the taxable year or $5,000 ($10,000 in the case

of a corporation).    For purposes of this computation, the amount

of the understatement is reduced to the extent attributable to an

item:   (1) For which there existed substantial authority for the

taxpayer’s treatment thereof, or (2) with respect to which
                                - 21 -

relevant facts were adequately disclosed on the taxpayer’s return

or an attached statement and there existed a reasonable basis for

the taxpayer’s treatment of the item.    See sec. 6662(d)(2)(B).

       An exception to the section 6662(a) penalty is set forth in

section 6664(c)(1) and reads:    “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.”

       Regulations interpreting section 6664(c) state:

            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. * * * Generally, the most important
       factor is the extent of the taxpayer’s effort to assess
       the taxpayer’s proper tax liability. * * * [Sec.
       1.6664-4(b)(1), Income Tax Regs.]

       Furthermore, reliance upon the advice of an expert tax

preparer may, but does not necessarily, demonstrate reasonable

cause and good faith in the context of the section 6662(a)

penalty.    See id.; see also Freytag v. Commissioner, supra at

888.    Such reliance is not an absolute defense, but it is a

factor to be considered.    See Freytag v. Commissioner, supra at

888.    In order for this factor to be given dispositive weight,

the taxpayer claiming reliance on a professional must show, at

minimum, that (1) the preparer was supplied with correct

information and (2) the incorrect return was a result of the

preparer’s error.    See, e.g., Westbrook v. Commissioner, 68 F.3d
                              - 22 -

868, 881 (5th Cir. 1995), affg. T.C. Memo. 1993-634; Cramer v.

Commissioner, 101 T.C. 225, 251 (1993), affd. 64 F.3d 1406 (9th

Cir. 1995); Ma-Tran Corp. v. Commissioner, 70 T.C. 158, 173

(1978); Pessin v. Commissioner, 59 T.C. 473, 489 (1972); Garcia

v. Commissioner, T.C. Memo. 1998-203, affd. without published

opinion 190 F.3d 538 (5th Cir. 1999).

     The notice of deficiency issued to petitioners asserted

applicability of the section 6662(a) penalty on account of both

negligence and/or substantial understatement.   (The notice also

referenced substantial valuation overstatement as an additional

alternative ground, see sec. 6662(b)(3), but since valuation was

not a focus of this case, we disregard the apparent boilerplate

reference.)   Based upon our holdings above, the evidence has now

established that petitioners understated their taxes by more than

the greater of $5,000 or 10 percent of the tax required to be

shown.   In addition, we observe that there exists no substantial

authority for deduction of unsubstantiated expenses and that

petitioners’ return disclosed no facts related to their claimed

expenses.   Accordingly, respondent has satisfied the burden of

production under section 7491(c) with respect to the section

6662(a) penalty for substantial understatement.   We also note,

for the sake of completeness, that petitioners’ demonstrated
                              - 23 -

failure to keep adequate records and properly substantiate would

be sufficient to sustain respondent’s burden for a negligence-

based imposition as well.

     Furthermore, petitioners have failed to prove their

entitlement to relief under the section 6664 exception.    An

absence of records, due to loss or destruction, cannot standing

alone establish that petitioners’ deductions were founded on

reasonable cause and good faith when made.    In addition, the

explanation offered for why petitioners retained no records from

EJX can only be described as vague at best.    The role of their

alleged return preparer, who we note did not sign the return, is

also less than clear.   More importantly, there has been no

showing that the return preparer was provided with accurate

information such that any errors are attributable to him and not

to petitioners.   We hold that petitioners are liable for the

section 6662(a) accuracy-related penalty.

     To reflect the foregoing,



                                         Decision will be entered

                                    under Rule 155.
