                            T.C. Memo. 1996-522



                          UNITED STATES TAX COURT



              ERNEST L. AND KATHLEEN NEWSOME, Petitioners v.
               COMMISSIONER OF INTERNAL REVENUE, Respondent


        Docket No. 23323-94.                  Filed November 26, 1996.


        James L. Robertson, for petitioners.


        Alvin A. Ohm, for respondent.


                            MEMORANDUM OPINION


        CARLUZZO, Special Trial Judge:    This case was heard pursuant

to the provisions of section 7443A(b)(3) and Rules 180, 181, and

182.1       Respondent determined deficiencies in petitioners' 1991



        1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years at issue. All
Rule references are to the Tax Court Rules of Practice and
Procedure.
                                - 2 -

and 1992 Federal income taxes in the amounts of $5,256 and

$5,169, respectively.

     The issue for decision is whether petitioners underreported

gross receipts from a newspaper delivery service business

conducted by Ernest L. Newsome during 1991 and 1992.

Background

     Some of the facts have been stipulated, and they are so

found.   At the time of the filing of the petition, petitioners

resided in Fort Worth, Texas.    References to petitioner are to

Ernest L. Newsome.

     Starting as a child, and for a number of years prior to the

years in issue, petitioner had been employed, in various ways, as

a newspaper carrier or delivery person.    He began delivering

newspapers for the Fort Worth Star Telegram (the Star Telegram)

sometime in the early 1980's.    During the years in issue he

delivered newspapers for the Star Telegram on an independent

contractor basis.    Using the cash receipts and disbursements

method of accounting, petitioner reported the income earned and

the expenses incurred in the operation of his newspaper delivery

service business on Schedules C for the years 1991 and 1992.

     During the years in issue, the Star Telegram published

morning and evening editions from Monday through Friday, and a

single edition on Saturdays and Sundays.    Consequently,

petitioner delivered newspapers to his customers twice a day

during the week and once per day on Saturdays and Sundays.
                                - 3 -

     In 1991 and 1992, the Star Telegram offered 4 basic

subscription plans, each having a distinct subscription rate.

The subscription rate for daily (the morning or evening edition,

Monday through Friday) and weekend (Saturday and Sunday) service

was $10.95 per month.    The subscription rate for daily service

was $8.95 per month.    Weekend service, which included Fridays,

cost the subscriber $7.95 per month, and a combination service,

which included the morning and the evening weekday editions, and

the weekend editions, cost $12.95 per month.    In addition to

these subscription plans, from time to time the Star Telegram

offered various discounts and promotions to different categories

of subscribers.

     Although the subscription rates were set by the Star

Telegram, the revenue generated through collections from the

subscribers on petitioner's delivery route belonged to him, not

the Star Telegram.    In effect, petitioner purchased the

newspapers from the Star Telegram and in turn sold them to his

customers.    As best we can determine from the record, a

subscriber to the Star Telegram was required to pay on a monthly

basis, regardless of the subscription plan.    A small percentage

of petitioner's customers mailed their payments directly to the

Star Telegram, and petitioner received credit for these payments

against his liability to the Star Telegram for the cost of the

newspapers.
                               - 4 -

     To collect from those customers who did not mail their

payments directly to the Star Telegram, petitioner had to go from

"door to door", which was a time consuming process.   Customers

who paid the petitioner in this manner did so by checks made

payable to the Star Telegram, or in cash.    Petitioner turned the

checks over to the Star Telegram, and if his monthly liability to

Star Telegram was satisfied, he received a Star Telegram check

for the amount turned over.   If he had an outstanding liability,

the checks he turned over were credited against the liability.

Petitioner kept the cash that he collected from his customers in

a bag in his house.   Petitioner used this cash to pay the balance

of his liability to the Star Telegram after payments made by

check were taken into account, and for daily operating expenses.

Although we cannot estimate the amounts with any degree of

precision, it appears that petitioner made substantial cash

payments to the Star Telegram each month for the newspapers that

he purchased for his delivery route.

     Because such a small percentage of petitioner's customers

mailed their payments directly to the Star Telegram, and due to

the nature of areas that petitioner served, petitioner considered

his delivery route relatively undesirable.   His route included

apartment complexes and trailer parks that had transient

populations, and some of the area's less desirable residential

neighborhoods.
                                - 5 -

     When petitioner picked up the newspapers from the Star

Telegram for delivery, a "draw" sheet was attached to the bundles

of newspapers indicating the number of newspapers to be

delivered.    A "draw" is the number of newspapers petitioner

received from the Star Telegram for delivery to subscribers on

his delivery route.    Normally petitioner was given extra

newspapers.    Petitioner used the extra newspapers to replace ones

that were damaged.    In addition to the draw sheets provided to

petitioner on a daily basis, each month the Star Telegram

provided petitioner with a circulation statement that indicated

the number of newspapers petitioner was being charged for, the

cost to petitioner of each newspaper, and, after various

adjustments,2 the amount that petitioner owed to the Star

Telegram for the newspapers he received during the month.

Normally petitioner attempted to satisfy his liability to the

Star Telegram by the 15th day of the following month.

     Although the circulation statement reflected the number of

newspapers charged to petitioner, it did not indicate the number

of subscribers, or reflect any information regarding subscription

plans.   Petitioner had approximately 925 customers in 1991 and


     2
      Adjustments were made for refunds, payments from
subscribers that were mailed directly to the Star Telegram,
surety charges (to insure that petitioner would pay the bill),
charge backs for returned checks (regardless of whether they were
mailed to the Star Telegram or turned over to the Star Telegram
by petitioner), and the application of credits related to special
promotions or discounts.
                               - 6 -

725 in 1992.   Most of petitioner's customers subscribed to either

the daily and weekend subscription plan, or the weekend only

subscription plan.   About 75 of petitioner's customers subscribed

to the combination plan, and about 5 customers subscribed to the

weekday only plan.

     The Star Telegram provided petitioner with a ledger book

that contained 12 receipts (one per month) for each of the

subscribers on petitioner's route.     On a weekly basis, the Star

Telegram also provided petitioner with a sticker for each

subscriber that included the subscriber's name, address, and

telephone number, the type of newspaper delivery service, and

information regarding discounts.   Once the subscriber paid him,

petitioner gave the subscriber a receipt from the ledger.

Petitioner used this ledger book to record the payments made by

his customers and to keep track of a customer's outstanding

liability to him.

     From time to time petitioner's customers would move away

from his delivery route, cancel their subscription for various

reasons, temporarily suspend service for vacations, etc., or fail

to pay for the newspapers delivered to them.    In these and

similar circumstances, petitioner would turn in a "stop" to the

Star Telegram.   The Star Telegram did not process these "stops"

efficiently, and there was a time lag between the date that

petitioner would turn in a "stop" and the date that the "stop"

would be taken into account in petitioner's daily "draw".      When
                                 - 7 -

petitioner turned in a "stop", he turned in the ledger receipts

for that subscriber.

     During the years in issue, petitioners maintained a joint

personal checking account.   Petitioner did not maintain a

separate account for his newspaper delivery service.    During the

years 1991 and 1992, petitioners deposited $25,535.97 and

$24,030.84, respectively, into the joint account.   The sources of

the deposits were not specifically identified, but most likely

included the net wages earned by Kathleen Newsome during those

years, unemployment compensation paid to one or both of the

petitioners, and on occasion earnings attributable to one of

their children.   Checks that petitioner received from the Star

Telegram were also deposited into this joint account.

Considering the amounts of the specific deposits it appears that

few consisted of cash.   Petitioner did not make any payments to

the Star Telegram with checks drawn on this joint account.

     In addition to items not in dispute, the Schedules C

relating to petitioner's newspaper delivery service business

included with petitioners' 1991 and 1992 Federal income tax

returns reflect the following:

                                   1991         1992

  Gross receipts or sales        $21,000      $21,500
  Cost of goods sold               3,329        2,905


Included in the computation of cost of goods sold for each year

were amounts for materials, supplies, and labor.    No portion of
                                - 8 -

the cost of goods sold reported for either year included the cost

of the newspapers that petitioner purchased from the Star

Telegram.    Petitioner estimated the amount of gross receipts

reported on the Schedules C based upon the checks that he

received from the Star Telegram.

     Revenue Agent Heidi Wilder (Agent Wilder) conducted the

examination of petitioners' 1991 and 1992 Federal income tax

returns.    Agent Wilder used the actual charges reflected on the

monthly circulation statements to determine petitioner's cost of

goods sold for 1991 and 1992.    Petitioners agree that Agent

Wilder accurately calculated the cost of goods sold for each

year.

     Agent Wilder used other information contained on the

statements to calculate petitioner's gross receipts for the years

1991 and 1992.    First, she calculated an average evening "draw"

number for each month by adding the evening "draw" numbers for

Monday through Friday from the circulation statement for that

month and dividing that figure by the number of weekday delivery

days in the month.    She did the same for the morning "draws".

Next, Agent Wilder calculated an average Saturday "draw" number

for each month by adding the Saturday "draw" numbers and dividing

that figure by the number of Saturdays in the month.    Agent

Wilder then added the average evening "draw" figure to the

average morning "draw" figure to obtain an average daily "draw"

number.    This figure was then subtracted from the average
                               - 9 -

Saturday "draw" number to obtain the "weekend differential".

Next, Agent Wilder multiplied the average daily "draw" number by

$10.95 (the daily and weekend rate), and then multiplied the

average Saturday "draw" figure, or weekend differential, by $7.95

(the weekend rate).   These two figures were added together to

obtain the total gross receipts for that month.    Agent Wilder

completed similar computations for each month for the years in

issue in order to estimate gross receipts for each year.    Gross

receipts for each year were then reduced by 10 percent for

uncollectibles.   The term "uncollectibles" refers to amounts that

could not be collected from subscribers for their newspaper

delivery service.   The Star Telegram advised Agent Wilder that

the uncollectible rate ranged from a low of 5 percent to a high

of 10 percent, depending on the nature of the delivery route.

     Agent Wilder's method of computing gross receipts did not

take into account awards or discounts offered by the Star

Telegram.   Nor did it take into account the extra newspapers that

petitioner had after completing his deliveries.    Furthermore,

because Agent Wilder did not have access to the ledger sheets,

she could not determine the actual numbers of subscribers to the

various subscription plans.   Consequently, her computations only

take into account the two subscription plans to which

petitioner's customers most commonly subscribed.

     Prior to the examination of petitioners' 1991 and 1992

returns, respondent's agents examined the returns of 200 to 300
                              - 10 -

newspaper carriers as part of a compliance research project.    In

addition, respondent's agents questioned the Star Telegram about

how the figures on the monthly circulation statements were

calculated.   As a result of these other examinations and the

information received from the Star Telegram, respondent developed

a ratio between the cost of the newspapers charged to a newspaper

carrier and the newspaper carrier's gross receipts.     Agent Wilder

checked the accuracy of her estimates in this case against this

ratio and found them to be within an acceptable range.

     Based upon Agent Wilder's calculations, in the notice of

deficiency respondent determined that the gross receipts and cost

of goods sold of petitioner's newspaper delivery service were as

follows:

                                 1991           1992

  Gross receipts or sales      $104,929       $93,323
  Cost of goods sold             71,288        58,848


As previously noted, petitioners now agree that the cost of goods

sold amounts are accurate.   After taking into account the amounts

reported on the Schedules C for these items and an adjustment not

in dispute, respondent increased petitioners' income by $14,842

and $14,758 for the years 1991 and 1992, respectively.3

     3
      Due to these changes, respondent increased petitioners'
liability for the self-employment tax imposed by sec. 1401 and
determined that petitioners were ineligible for the earned income
credit. These adjustments are not in dispute and will be
resolved in accordance with the resolution of the disputed issue.
                                - 11 -

Discussion

     Respondent's reconstruction of petitioners' income for each

year in the notice of deficiency is presumed correct and the

burden is on petitioners to demonstrate otherwise.     Rule 142(a);

Mallette Bros. Constr. Co. Inc. v. United States, 695 F.2d 145,

148 (5th Cir. 1983).

     Petitioners contend that the method by which respondent

calculated petitioner's gross receipts is flawed for various

reasons.     They argue that respondent has overestimated gross

receipts because of her failure to take into account: (1) Special

discounts and promotions offered by the Star Telegram; (2) the

time lag in processing each "stop" resulting in extra newspapers

that generated no revenues; and (3) a higher than allowed rate of

uncollectibles due to the nature of petitioner's route.

Petitioners further argue that respondent's use of only two

subscription rates and assumption that each "average" subscriber

paid for a full monthly subscription artificially inflates the

amount of gross receipts.     Lastly, petitioners generally

criticize respondent's use of average "draws" arguing that the

"draw" numbers regularly fluctuate and do not lend themselves to

estimates using averages.     In addition, petitioners argue that

their modest lifestyle is in accord with their reported income

and further demonstrates that respondent's determinations must be

erroneous and excessive.
                               - 12 -

     Respondent argues that her estimates are as accurate as

possible, given the information that she had at the time.   If

there are any problems in her estimates, respondent suggests that

the problems were caused by petitioner's own record keeping

failures.    For the following reasons, we agree with respondent.

     Taxpayers have the obligation to maintain sufficient books

and records in order to allow for the determination of income and

expenses, and such books and records are to be kept available for

inspection by respondent.   Sec. 6001; sec. 1.6001-1(e), Income

Tax. Regs.   There is some dispute whether petitioners produced

any books and records for respondent's review during the

examination stage, although we find it unlikely that they did.

It is clear, however, that books and records were kept, but for

reasons unexplained, petitioners did not produce them at trial.

Absent such books and records, we review respondent's method of

reconstructing petitioners' income not so much for precision, but

for reasonableness under the circumstances.    Holland v. United

States, 348 U.S. 121 (1954); Giddio v. Commissioner, 54 T.C.

1530, 1533 (1970).   Applying this standard of review, none of

petitioners' attacks upon respondent's method has merit.4   While

     4
      We disagree with petitioners' contention that regular
fluctuations in the number of "draws" renders the use of averages
invalid. Petitioners have not called our attention to any
statistical principles that support this proposition, and given
the intended use of such averages, the opposite seems obvious to
us. We also disagree with petitioners' assertion that the rate
of uncollectibles respondent used was too low. The amount was
the highest rate provided by the Star Telegram. We are also
                              - 13 -

respondent's method of calculating petitioner's gross receipts

may not be perfect, it is certainly reasonable under the

circumstances.   As the Court of Appeals for the Fifth Circuit

observed in Webb v. Commissioner, 394 F.2d 366, 373 (5th

Cir.1968), affg. T.C. Memo. 1966-81:

          Arithmetic precision was originally and
     exclusively in * * * [the taxpayer's] hands, and he had
     a statutory duty to provide it. He did not have to add
     or subtract; rather, he had simply to keep papers and
     data for others to mathematicize. Having defaulted in
     his duty, he cannot frustrate * * * [respondent's]
     reasonable attempts by compelling investigation and
     recomputation under every means of income
     determination. * * *

     In this case, it is obvious that the amounts reported by

petitioners for gross receipts and cost of goods sold on the

Schedules C were substantially understated.   Had petitioners

produced any books and records, we have no doubt that little

support would have been provided for the amounts reported on

petitioners' Federal income tax returns.   It is also obvious that

a significant portion of petitioner's newspaper delivery service

business was conducted in cash.   We believe that the gross

receipts petitioners reported on the Schedules C failed to take

into account considerable amounts of cash payments that

petitioner collected from his customers.


satisfied that had respondent taken into account petitioners'
other concerns, such as the extra newspapers, the fact that 75 of
petitioner's customers subscribed to the combination plan, and
the fact that 5 of petitioner's customers subscribed to the
weekday only subscription plan, only de minimis changes to her
estimates would have resulted.
                             - 14 -

     In addition, we find respondent's conclusions supported by

the fact that her estimates of petitioner's gross receipts are in

line with the results that respondent observed in the

examinations of similarly situated taxpayers and supported by

information received from the Star Telegram.    We also note that

petitioners' incomes as determined in the notice of deficiency

are more consistent with the transactions reflected on the

records of petitioners' joint checking account than the incomes

reported on their Federal income tax returns.

     Accordingly, the determinations made by respondent in the

notice of deficiency are sustained.

     To reflect the foregoing,

                                           Decision will be entered

                                      for respondent.
