                        T.C. Memo. 2019-95



                  UNITED STATES TAX COURT



  HISHAM N. ASHKOURI AND ANN C. DRAPER, Petitioners v.
    COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 17514-15.                         Filed July 30, 2019.



       Ps' Federal income tax return for each of 2009, 2010, and 2011
included a Schedule C, Profit or Loss From Business, for a real estate
development business P-H conducted. Each of P-H's Schedules C
reported, among other expenses, payments to his wholly owned
corporation (A) for marketing materials he used in pursuit of
development projects. During 2010, A received payments from a
client for a business plan prepared for a project in RF. During 2011,
P-H's wholly owned limited liability company (LLC) sold a unit (B)
in a condominium project that LLC developed.

       R's notice of deficiency disallowed the deduction of all of the
expenses reported on P-H's Schedules C for 2009 through 2011 and
determined accuracy-related penalties under I.R.C. sec. 6662(a). By
amendment to his answer, R asserted that the payments received for
the business plan were includible in Ps' income and that Ps
mischaracterized the gain from LLC's sale of B. On brief, R asserted
that Ps also understated the amount of that gain.
                                          -2-

[*2]          Held: P-H's payments to A were bidding costs, subject to sec.
       1.263A-1(e)(3)(ii)(T), Income Tax Regs., rather than marketing,
       selling, advertising, or distribution costs subject to sec. 1.263A-
       1(e)(3)(iii)(A), Income Tax Regs.

              Held, further, Ps failed to establish that any of P-H's bidding
       costs became deductible during the years in issue.

             Held, further, Ps conceded the other deductions claimed on
       P-H's Schedules C by failing to include in their opening brief any
       meaningful argument in support of those deductions.

              Held, further, R failed to meet his burden of proving that P-H,
       rather than A, was entitled to the consideration paid for the business
       plan.

              Held, further, because LLC held B primarily for sale to
       customers in the ordinary course of business, the gain recognized
       from the sale of B was not "section 1231 gain", as defined by I.R.C.
       sec. 1231(a)(3)(A).

             Held, further, the issue of the amount of gain from the sale of B
       was not tried by the parties' consent.

              Held, further, R met his burden of production establishing the
       appropriateness of the accuracy-related penalties he determined, and
       Ps failed to establish any valid defense to those penalties.



       Harvey J. Cavayero, for petitioners.

       Marissa J. Savit and Lyle B. Press, for respondent.
                                         -3-

[*3]        MEMORANDUM FINDINGS OF FACT AND OPINION


       HALPERN, Judge: By a notice of deficiency dated April 16, 2015,

respondent determined deficiencies of $71,827, $44,809, and $68,873 in

petitioners' Federal income tax for 2009, 2010, and 2011, respectively.

Respondent also determined accuracy-related penalties for those years of $14,365,

$8,767, and $13,775, respectively. By amendment to his answer, respondent

asserted additional deficiencies and penalties for each year as a result of income

items that he claims petitioners failed to correctly report on their returns. We must

decide whether petitioners are entitled to deduct expenses reported on Schedule C,

Profit or Loss From Business, in the following amounts for the taxable (calendar)

years indicated:

                Expenses               2009          2010         2011
       Other                        $229,194      $104,624      $223,813
       Meals and entertainment              49        1,325         1,001
       Travel                           1,801        50,017         ---
       Office                           1,775         5,021         ---
                                         -4-

[*4] We must also decide whether petitioners' taxable income for 2010 and 2011

includes State tax refunds petitioner Mr. Ashkouri received in each of those years,1

whether their taxable income for 2010 should be increased by $69,798 to reflect

payments made by Manaff Sagdiev for a business plan related to a development

project in the Russian Federation, whether gain recognized in 2011 from the sale

of a unit in a condominium complex by Mr. Ashkouri's wholly owned limited

liability company (LLC) was properly reported as capital gain or instead should be

recharacterized as ordinary income, and whether petitioners are subject to

accuracy-related penalties under section 6662(a) for the years in issue. Unless

otherwise indicated, all section references are to the Internal Revenue Code in

effect for the years in issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure. We round all dollar amounts to the nearest dollar.

                               FINDINGS OF FACT

      During the years in issue and when they filed their petition in this case,

petitioners resided in Newton Highlands, Massachusetts, 02461.




      1
        In the amendment to his answer, respondent asserted that petitioners
inappropriately excluded from their taxable income for each year in issue an
income tax refund Mr. Ashkouri received from the State of Massachusetts. On
brief, however, respondent abandoned his argument concerning the refund Mr.
Ashkouri received in 2009.
                                         -5-

[*5] Mr. Ashkouri's Business Pursuits

      During the years in issue, Mr. Ashkouri pursued real estate development

projects under the name "Hisham Ashkouri, Architects". For one of those

projects, Mr. Ashkouri formed an LLC, Cold Spring Green (CSG). Mr. Ashkouri

was also the sole shareholder and officer of ARCADD, Inc. (ARCADD), a

domestic corporation that provided architectural and design services. ARCADD

reports its income on the basis of a June 30 fiscal year.

Development Projects Pursued Through Proprietorship

      Mr. Ashkouri hired ARCADD to assist him in his pursuit of development

projects by preparing what he referred to as "marketing" materials, such as

building designs, brochures, and three-dimensional drawings. Ultimately,

however, Mr. Ashkouri did not end up serving as developer of any of the projects

he pursued. A potential project in Libya could not go forward because of

hostilities in that country. Other projects in Washington State and Utah proved

unsuccessful because of a lack of financing. If any of those projects had resulted

in "a real estate transaction", Mr. Ashkouri testified, "I would be having 20

percent ownership."
                                          -6-

[*6] Payments for Business Plan for Russian Federation Project

      In June and July of 2010, Mr. Sagdiev made two wire transfers of $34,899

each to an insured money market account that ARCADD held with Citibank. Mr.

Sagdiev made the payments in consideration of a business plan for the

development of a new city in Tatarstan, Russian Federation. The funds were

wired to ARCADD's account at Mr. Ashkouri's direction.

      The business plan for the Russian Federation project identifies Noorland-

Ltd. as the development's "owner" and ARCADD and Hisham Ashkouri,

Architects, as consultants on urban and architectural design and project

management. Although Mr. Ashkouri hoped to serve as developer of the project,

he provided no further work beyond the business plan after Mr. Sagdiev failed to

make a required third payment.

      As explained below, ARCADD reported its receipt of the June wire transfer

from Mr. Sagdiev on both its books and tax records but mischaracterized the

receipt. It did not report the funds as fee revenue but instead as either interest

income or as a lawsuit recovery. The balance of ARCADD's insured money

market account with Citibank as of June 30, 2010, as reported on ARCADD's

balance sheet as of that date, matched the amount shown on a bank statement

Citibank issued. The yearend balance of the Citibank account was recorded on
                                        -7-

[*7] ARCADD's books as part of a larger adjusting entry, the credits of which

were to interest income ($6,537), lawsuit interest income ($608,801), and lawsuit

revenue ($1,544,463). ARCADD's Form 1120, U.S. Corporation Income Tax

Return, for the year ended June 30, 2010, reports interest income of $615,338

($6,537 + $608,801) and, on Schedule M-1, Reconciliation of Income (Loss) per

Books With Income per Return, nontaxable damages from a negligence lawsuit of

$1,530,375.2

      ARCADD included the July 2010 wire transfer in the fees revenue it

reported for both book and tax purposes of the year ended June 30, 2011. Again,

the yearend balance of ARCADD's insured money market account with Citibank

reported on its balance sheet matches the amount shown on Citibank's statement of

account. The adjusting entry made to reflect the balance of that account on

ARCADD's books included a credit to fees revenue of $34,899. And the total fees

revenue reported on ARCADD's adjusted trial balance for the year ended June 30,

2011, matched the revenue of $269,502 reported on its tax return for that year.




      2
       It appears that $14,088 of the amount recorded in the adjusting entry as
lawsuit revenue was included in the $17,088 of fees revenue that ARCADD
reported for both book and tax purposes for the year ended June 30, 2010. Thus,
the nontaxable income reported on Schedule M-1 is $14,088 less than the
$1,544,463 of lawsuit revenue recorded in the adjusting entry.
                                        -8-

[*8] Cold Spring Green

      Mr. Ashkouri was the sole member of CSG, which developed a

condominium project at 1188 and 1192 Beacon Street, Newton, Massachusetts. In

September 2011, CSG sold unit B at 1188 Beacon Street (Unit B) for $1,250,622.

      CSG's sole purpose and function was to acquire, hold, develop, operate, and

sell the condominium complex of which Unit B was a part. CSG funded its

development activities with a $3,933,000 construction loan from Mount

Washington Bank and entered into at least nine contracts with subcontractors

(including ARCADD). It relied on the services of Gibson Sotheby's International

Realty to market the two units at 1188 Beacon Street for sale to customers.

      In an email exchange in October 2011, petitioners' accountant, Randy

Rogers, asked Mr. Ashkouri about Unit B's "approximate cost basis". Mr.

Ashkouri responded that he expected that the total costs for CSG's condominium

development "will be about $4,566,888."

Refunds of Massachusetts Income Tax

      During 2009, ARCADD withheld $5,232 of Massachusetts income tax from

the wages it paid Mr. Ashkouri. For 2009, Mr. Ashkouri filed a Form 1,

Massachusetts Resident Income Tax Return, that reported a tax of $7 and
                                         -9-

[*9] requested a refund of $5,225 ($5,232 ! $7), which Massachusetts paid him in

2010.

        During 2010, ARCADD withheld $5,038 of Massachusetts income tax from

Mr. Ashkouri's wages. For 2010, Mr. Ashkouri filed a Form 1 reporting a tax of

$38 and requesting a refund of $5,000 ($5,038 ! $38), which Massachusetts paid

him in 2011.

Petitioners' Tax Returns

        2009

        Petitioners filed Form 1040, U.S. Individual Income Tax Return, for 2009

reporting total tax of $112,148, including alternative minimum tax (AMT) of

$29,427 reported on line 45. Schedule A, Itemized Deductions, of petitioners'

2009 Form 1040 reports $77,548 of State and local income taxes. A

supplementary schedule shows that petitioners' deduction for State and local

income taxes for 2009 includes the $5,232 of Massachusetts income tax withheld

by ARCADD.

        Petitioners' 2009 return includes a Schedule C for Mr. Ashkouri's

proprietorship that reports total expenses of $232,819, including office expense,

expenses for travel, meals, and entertainment, and "Other expenses". The other
                                        -10-

[*10] expenses, reported on line 27, total $229,194 and include $221,530 labeled

"Architectural Services".

       2010

       Petitioners' 2010 Form 1040 reports wages, salaries, and tips of $250,406,

taxable interest of $1,413, and dividends of $1,437. Petitioners reported adjusted

gross income (AGI) of $78,533, itemized deductions of $74,356 (including State

and local income taxes of $19,3103), and exemptions of $7,300. Because the

itemized deductions and exemptions exceeded their AGI, petitioners reported no

taxable income. Their reported tax of $85 consisted entirely of self-employment

tax.

       The 2010 Schedule C for Mr. Ashkouri's proprietorship reports total

expenses of $160,987, including office expense, expenses for travel, meals, and

entertainment, and "Other expenses". The other expenses, reported on line 27,

total $104,624 and include $86,571 labeled "Architectural Services".




       3
       Petitioners' 2010 Schedule A makes no reference to a supplemental
statement detailing the items included in the total of State and local income taxes
reported, and the copy of petitioners' 2010 Form 1040 which the parties stipulated
does not include supplemental statements.
                                        -11-

[*11] 2011

      Petitioners' 2011 Form 1040 reports total tax of $1,057. Line 10 of that

form, "Taxable refunds, credits, or offsets of state and local income taxes", reports

zero and refers to supplementary statements 1 and 2. Statement 1 attached to

petitioner's 2011 return reports refunds of $5,000 from Massachusetts and $610

from New York. Statement 2, captioned "Taxable State and Local Income Tax

Refunds", appears to be a standard, computer-generated form. The first line,

labeled "Net Tax Refunds From State and Local Income Tax Refunds Stmt.",

reports the $5,610 of total refunds shown on Statement 1. The second line, labeled

"Less: Refunds--No Benefit Due to AMT-Sales Tax Benefit Reduction", also

reports $5,610. That subtraction leaves no amount on the following line, "Net

Refunds for Recalculation", and the last line of Statement 2 thus shows zero as

"Total to Form 1040, Line 10".

      The 2011 Schedule C for Mr. Ashkouri's proprietorship reports supplies

expense, expenses for meals and entertainment, and "Other expenses". The other

expenses, reported on line 27a, total $223,813 and include $221,322 labeled

"Payments to ARCADD * * * for Contract Services".
                                         -12-

[*12] Petitioners' 2011 return includes Form 4797, Sales of Business Property,

that reports CSG's sale of Unit B.4 Petitioners computed the gain on the sale by

offsetting CSG's $1,250,622 amount realized by a tax basis of $1,234,677,

resulting in a net gain of $15,945. Because the gain from CSG's sale of Unit B

was not offset by losses from other transactions reported on their Form 4797,

petitioners reported the gain as capital gain on their 2011 Schedule D, Capital

Gains and Losses.

      Petitioners' Form 1040 for each of the years in issue includes Form 8275,

Disclosure Statement, that lists some or all of the expenses reported on the

Schedule C for Mr. Ashkouri's proprietorship.5 Mr. Rogers testified that he




      4
        Petitioners' reporting of the sale on their own return was consistent with
their established practice, which the parties stipulated, of treating CSG's activities
as a business of Mr. Ashkouri's.
      5
       The Forms 8275 included in petitioners' 2009 and 2010 returns cover all of
the expenses reported on the Schedule C for Mr. Ashkouri's proprietorship for
those years. The Form 8275 included in petitioners' 2011 return covers the
$221,322 reported as payments to ARCADD for contract services.
                                        -13-

[*13] included Form 8275 in petitioners' 2010 return because he was not sure that

the reported amounts were deductible and he wanted to avoid preparer penalties.6

The Notice of Deficiency

      As noted at the outset, respondent's notice of deficiency determined

deficiencies of $71,827, $44,809, and $68,873 in petitioners' Federal income tax

and accuracy-related penalties of $14,365, $8,767, and $13,775 for 2009, 2010,

and 2011, respectively. The notice includes Form 5278, Statement--Income Tax

Changes, that lists the adjustments made in computing petitioners' deficiencies.

The only noncomputational adjustments shown on the Form 5278 involve the

disallowance of the deductions claimed on the Schedules C for Mr. Ashkouri's

proprietorship for the years in issue. Those adjustments result in total corrected

tax liabilities of $183,975, $44,094, and $69,930 for 2009, 2010, and 2011,

respectively.

Determination and Approval of Accuracy-Related Penalty

      The accuracy-related penalty determined in the notice of deficiency for each

of the years in issue was proposed by Steven Wong, who examined petitioners'


      6
        Although Mr. Rogers' testimony specifically addressed only the Form 8275
filed with petitioners' 2010 return, we assume that the Forms 8275 included with
petitioners' returns for 2009 and 2011 were also filed at Mr. Rogers' behest and for
similar reasons.
                                       -14-

[*14] returns for those years. The penalties were approved in writing by Lynda

Diamond, Mr. Wong's acting group manager.

Petitioners' Substantiation

      2009 Meals and Entertainment

      To substantiate the $49 of deductible meals and entertainment expenses

reported on the 2009 Schedule C for Mr. Ashkouri's proprietorship, petitioners

provided respondent's counsel with credit card statements showing charges at

three restaurants that total $117. The statements provide no information about any

meal other than the date, the name of the restaurant, and the amount charged.

      2011 Meals and Entertainment

      Petitioners provided similar substantiation in regard to the $1,001 of

deductible meals and entertainment expenses reported on Mr. Ashkouri's 2011

Schedule C. The charges shown on the credit card statements, however, total only

$945 and, again, those statements provide no information about any meal other

than the date, the name of the restaurant, and the amount charged.

      2009 Travel Expense

      To substantiate the $1,801 travel expense reported on Mr. Ashkouri's 2009

Schedule C, petitioners provided respondent's counsel with credit card statements

showing charges of $250 to MedJet Assistance, $396 to Visas & Passports 2 Go,
                                        -15-

[*15] and $1,555 to British Airways for tickets. Other than indicating that the

charge from British Airways was for tickets, the credit card statements provide no

information about the nature of the expenses.

      2009 Office Expense

      To substantiate the $1,775 office expense reported on Mr. Ashkouri's 2009

Schedule C, petitioners provided respondent's counsel with credit card statements

showing charges at Staples that total $1,429. The credit card statements provide

no information other than the vendor, date, and amount of each charge.

      Architectural or Contract Services

      To substantiate the $221,322 "Contract Services" expense reported on the

Schedule C for Mr. Ashkouri's proprietorship for 2011, petitioners provided

respondent's counsel with a spreadsheet listing deposits that total that amount

made to an account ARCADD held with Citibank. The deposits are further

evidenced by bank statements and deposit slips, most of which identify Mr.

Ashkouri as the depositor.

      Petitioners provided similar documentation in regard to the $221,530

"Architectural Services" expense reported on Mr. Ashkouri's 2009 Schedule C,

except that the deposits listed on the spreadsheet, made to an account with
                                        -16-

[*16] Citizens Bank, total only $221,500, and the deposit slips do not identify the

depositor.

      For 2010, petitioners also provided a spreadsheet listing deposits along with

supporting documentation, but the deposits total $181,743--far more than the

$86,571 reported on Mr. Ashkouri's 2010 Schedule C as architectural services

expenses. Again, the accompanying deposit slips do not identify the depositor.

      None of the documentation of deposits to ARCADD's bank accounts for any

of the years in issue gives any indication of the purpose of the deposits.

Discovery

      Petitioners repeatedly failed to comply with respondent's requests for

admissions, for the production of documents, and for interrogatories, necessitating

our issuance of orders directing compliance.

      In his first request for admissions, respondent sought, among other things,

an admission that "Mr. Ashkouri's Schedule C architecture business did not

generate any gross receipts during the 2008, 2009, 2010, 2011, or 2012 tax years."

In their belated response, petitioners denied that requested admission, noting Mr.

Ashkouri's receipt of loans and proceeds from the sale of units in CSG's

condominium development. They also stated that Mr. Ashkouri "received
                                        -17-

[*17] additional money for the development of a business plan for the new City of

Noorland, Russian Federation."

      In their response to respondent's interrogatories, petitioners advised

respondent's counsel: "The Petitioner [apparently a reference to Mr. Ashkouri]

received 2/3 payment on a full contract for $105,000 to complete the Business

Plan for the City of Noorland which was promptly paid to ARCADD, Inc. Hisham

Ashkouri completed the work at 100% and submitted the Business Plan to his

client Mr. Mannaf Sagdiev of Kazan, Tatarstan."

      In response to a request from respondent's counsel for statements of

accounts in which Mr. Ashkouri held an interest, petitioners stated that "[t]he

money transferred from the Russian Federation was deposited into an ARCADD

Citibank account". They acknowledged that the deposit into an ARCADD

account was contrary to what they had understood and believed during a prior

meeting with respondent's counsel in September 2016.

Respondent's Amendment to His Answer

      In December 2016, respondent sought leave to amend his answer. After we

granted that leave, respondent amended his answer, alleging:

      [P]etitioners are liable for increased tax deficiencies (and
      correspondingly increased accuracy-related penalties under I.R.C.
      § 6662(a)) for the following three unreported income items:
                                       -18-

[*18] (1) unreported state tax refunds received during the 2009, 2010, and
      2011 tax years on account of state taxes paid during the 2005, 2006,
      2009, and 2010 tax years; (2) unreported Schedule C gross receipts in
      the amount of $69,798 for services provided by Ashkouri for a project
      in the Russian Federation during the 2010 tax year, and
      (3) unreported Schedule C gross receipts in the amount of $15,945 for
      the 2011 tax year, on account of petitioners' mischaracterization of
      such income as capital gain.

Respondent's allegation regarding mischaracterized income relates to CSG's sale

of Unit B. His answer, as amended, challenges only the character of that gain--not

its amount.

Mr. Ashkouri's Testimony Concerning the Russian Federation Project

      On cross-examination, respondent's counsel asked Mr. Ashkouri about his

involvement in the Russian Federation project. Relevant portions of his testimony

follow:

            Q    And, in 2010, as compensation for your services, Mr.
      Sagdiev made two payments in the amount of $34,899 each?

              A    That's correct.

            Q    So, in 2010, you were paid a total of $69,798 for the
      Russian Federal project.

            A      That is incorrect. I want to say that because when you
      say you, it means Hisham Ashkouri. You have to say ARCADD
      received the money. It went to ARCADD's account.

            Q     So you told Mr. Sagdiev which bank account into which
      he should--
                                          -19-

[*19]         A     Yes.

              Q     --wire the payments?

              A     That's correct.

             Q     And you chose to have him wire the money into the Citi
        Bank account in the name of ARCADD?

              A     That's correct.

               Q     And the two payments he made were a payment for
        architectural and development services that you provided to him.

              A     Architectural services. It was a business plan that we
        developed for him.

              Q     It was you solely providing architectural services?

              A     Business plan, correct.

          *          *            *        *           *             *     *

              Q    * * * This is the proposal that you provided to--for the
        Russian Federation project.

              A     This is not the proposal.

              Q     What is it?

              A     This is the actual--this is the actual report.

              Q     Who prepared the report?

              A     ARCADD did.

          *          *            *        *           *             *     *
                                         -20-

[*20]         Q     Under Project Administration, it says Noorland, Ltd., is
        the owner and developer of Noorland new city project.
                    So Noorland, Ltd., was the developer of the project?

              A     That is correct.

              Q     ARCADD was not the developer of the project.

              A      No. I said that--I already stated that to you. That I
        would like to have been the developer for the project. This was at the
        end, but then the guy never paid the third payment, so I would not
        honor the agreement anymore.

          *          *          *          *          *          *          *

              Q    So your testimony is that your Schedule C was
        uninvolved with the Russian project?

              A     Absolutely.

Petitioners' 2011 Amended Return

        The parties stipulated that petitioners "provided respondent's counsel with

fourteen binders of documents"; but the stipulation does not include those binders

as exhibits, nor did petitioners seek on their own to introduce those binders at trial.

        The only document petitioners introduced into evidence on their own, in

addition to those which they jointly stipulated with respondent, is Form 1040X,

Amended U.S. Individual Income Tax Return, for 2011. The document, which is

stamped "Client Copy", bears the signatures of Messrs. Ashkouri and Rogers (as

preparer) but not that of Ms. Draper. The Schedule C for Mr. Ashkouri's
                                        -21-

[*21] proprietorship included in the 2011 amended return (and stamped "As

Amended") is identical to the Schedule C included in the 2011 return they filed.

                                     OPINION

I.    Introduction

      A.     Burden of Proof

      Rule 142(a)(1) provides: "The burden of proof shall be upon the petitioner,

except as otherwise provided by statute or determined by the Court; and except

that, in respect of any new matter, increases in deficiency, and affirmative

defenses, pleaded in the answer, it shall be upon the respondent."

      Section 7491(a)(1) may shift the burden of proof to the Commissioner as to

factual matters generally. That section applies, however, only if (among other

things) the taxpayer complies with substantiation requirements, maintains all

required records, and cooperates with the Commissioner's requests for witnesses,

information, documents, meetings, and interviews. See sec. 7491(a)(2)(A)

and (B).

      Petitioners make no argument that the conditions for shifting the burden of

proof have been met. Moreover, as explained below, petitioners did not establish

their compliance with the substantiation requirements governing the deductions in

issue. And they did not timely comply with respondent's discovery requests.
                                          -22-

[*22] We therefore conclude that respondent has the burden of proof in regard to

the three issues asserted by amendment to his answer. (In addition, as explained in

part IX below, respondent has the burden of production in regard to petitioners'

liability for accuracy-related penalties.) In all other respects, petitioners bear the

burden of proof.

      B.     Petitioners' Nonconforming Briefs and Resulting Concessions

      Rule 151(e) provides requirements for the form and content of briefs

submitted to this Court. Briefs must begin with "a table of contents with page

references, followed by a list of all citations arranged alphabetically as to cited

cases and stating the pages in the brief at which cited." Rule 151(e)(1). A party's

opening brief must include "[p]roposed findings of fact * * * based on the

evidence, in the form of numbered statements". Rule 151(e)(3). Each numbered

statement must include "references to the pages of the transcript or the exhibits or

other sources relied upon to support the statement." Id. A brief must also include

the party's "argument, which sets forth and discusses the points of law involved

and any disputed questions of fact." Rule 151(e)(5).

      Petitioners' opening brief fails in several respects to comply with Rule

151(e)'s requirements. It has no table of contents. It lacks a list of citations--

although that omission may be explained by the brief's failure to cite any cases and
                                           -23-

[*23] its almost complete lack of references to applicable statutory provisions.7

Eight numbered paragraphs follow the heading "Proposed Findings of Fact", but

those proposed findings are not supported by references to evidence in the record.

The balance of petitioners' opening brief consists primarily of factual statements,

although they are not identified as such and, again, are not accompanied by

references to the record. To the extent that their opening brief includes any

arguments at all, those arguments are conclusory, undeveloped, and unsupported

by references to applicable authorities.

      Because of petitioners' failure to support their proposed factual findings

with citations of the record,8 we have not relied on petitioners' proposals in

making our own findings. Instead, we have made our findings on the basis of the

record and adopted those of respondent's proposed findings that we determined to

be consistent with the record. See Van Eck v. Commissioner, T.C. Memo. 1995-


      7
        In apparent acknowledgment of respondent's argument that Mr. Ashkouri
had to capitalize the largest category of his reported Schedule C "Other expenses",
petitioners invoke the capitalization provision of sec. 263A but do so only in a
heading, without discussing any of that section's specific provisions or the
regulations that interpret them. We found no other references in petitioners'
opening brief to the statutory provisions relevant to the issues in the case.
      8
        Respondent lodged a general objection to all of petitioners' proposed
findings as a result of their failure to comply with Rule 151(e)(3) by including in
the findings references to the transcript, exhibit, or other supporting sources in the
record.
                                        -24-

[*24] 570, 1995 WL 700553, at *3-*4 (adopting a similar approach in a case

involving a taxpayer's failure to comply with Rule 151(e)(3)).

      In addition, we will treat petitioners as having conceded each issue in regard

to which their opening brief advances no meaningful legal argument.9 In past

cases in which a taxpayer's brief makes no argument on an issue or includes only

an undeveloped argument that fails to meet the requirements of Rule 151(e)(5), we

have treated the taxpayer as having conceded that issue. E.g., Bradley v.

Commissioner, 100 T.C. 367, 370 (1993); Adeyemo v. Commissioner, T.C.

Memo. 2014-1, at *28 ("The * * * [taxpayers'] brief points to no specific support,

from the record or elsewhere, for the proposition that they are entitled to

deductions for their rental real-estate business that were disallowed on lack-of-

substantiation grounds. The brief's failure to advance this issue beyond a vague




      9
        To the extent that petitioners' reply brief advances arguments, those
arguments, as well, tend to be undeveloped and conclusory. Petitioners' reply
brief reproduces, verbatim, respondent's opening brief and inserts occasional
responses. Even if petitioners advanced fully developed arguments in their reply
brief, however, we would decline to consider them. Having conceded an issue by
failing to advance a meaningful argument on that issue in their opening brief,
petitioners could not withdraw that concession by belatedly including a cognizable
argument in their reply brief. Cf. Considine v. Commissioner, 74 T.C. 955, 969-
970 (1980) (characterizing as "untimely" and thus declining to consider an
argument advanced for the first time in a reply brief).
                                        -25-

[*25] assertion convinces us that the * * * [taxpayers] have waived the issue.").

We will follow the same approach in the present case.10

II.   Schedule C Other Expenses

      A.     Introduction

      For each of the years in issue, the largest amount (by far) included in the

"Other expenses" reported on the Schedule C for Mr. Ashkouri's proprietorship is

the one described either as "Architectural Services" (on the Schedules C for 2009

and 2010) or "Payments to ARCADD * * * for Contract Services" (on the 2011

Schedule C). The amounts reported as payments for architectural or contract

services range from 83% to 99% of the total reported other expenses.

      Respondent claims that petitioners failed to substantiate any of the expenses

reported on the Schedules C for Mr. Ashkouri's proprietorship for the years in

issue. He makes an additional argument, however, in regard to the payments for

architectural or contract services, which he contends had to be capitalized under

section 263A.




      10
         If petitioners had appeared before us pro se, we might have been more
lenient in enforcing Rule 151(e), see, e.g., Veneziano v. Commissioner, T.C.
Memo. 2011-160, 2011 WL 2637281, at *1; but petitioners were represented (and
their briefs signed) by an attorney who, as a member of the Tax Court bar, should
have been familiar with the Court's Rules.
                                         -26-

[*26] We will thus consider Mr. Ashkouri's payments for architectural or contract

services separately from our consideration of the remaining other expenses.

      B.     Architectural or Contract Services

      Section 263A requires the capitalization of direct and indirect costs of

property produced by the taxpayer or property acquired by the taxpayer for resale.

Sec. 263A(a) and (b). For purposes of section 263A, the term "produce" means to

"construct, build, install, manufacture, develop, improve, create, raise, or grow."

Sec. 1.263A-2(a)(1)(i), Income Tax Regs. Thus, respondent contends: "To the

extent Ashkouri alleges that the expenses at issue were incurred to develop real

properties for his Schedule C business, such expenses must be capitalized and are

not currently deductible." Respondent adds that "there is insufficient information

in the record to establish whether petitioners are entitled to any portion of the

capitalized expenses during the Tax Years at Issue".

      In their opening brief, petitioners respond that the deductions in issue

"could not be capitalized as they were used for marketing and promotion with no

real estate transaction." Although petitioners fail to cite any authority in support

of that claim, they are correct that section 263A does not require the capitalization

of "marketing, selling, advertising, and distribution costs." See sec. 1.263A-

1(e)(3)(iii)(A), Income Tax Regs.
                                          -27-

[*27] Another provision of the regulations, however, convinces us that the

payments Mr. Ashkouri made to ARCADD for architectural or contract services

are not "marketing, selling, advertising, * * * [or] distribution costs" within the

meaning of section 1.263A-1(e)(3)(iii)(A), Income Tax Regs. Section 1.263A-

1(e)(3)(ii)(T), Income Tax Regs., requires a taxpayer to "defer all bidding costs

paid or incurred in the solicitation of a particular contract until the contract is

awarded." The treatment of those deferred costs depends on whether the taxpayer

receives the contract:

      If the contract is awarded to the taxpayer, the bidding costs become
      part of the indirect costs allocated to the subject matter of the
      contract. If the contract is not awarded to the taxpayer, bidding costs
      are deductible in the taxable year that the contract is awarded to
      another party, or in the taxable year that the taxpayer is notified in
      writing that no contract will be awarded and that the contract (or a
      similar or related contract) will not be rebid, or in the taxable year
      that the taxpayer abandons its bid or proposal, whichever occurs first.
      ***

Id.

      Section 263A would apply to Mr. Ashkouri's pursuit of development

projects, however, only if those projects would have resulted in his acquisition of

property. As noted above, that section requires the capitalization of costs of

property produced by the taxpayer. In general, however, "a taxpayer is not

considered to be producing property unless the taxpayer is considered an owner of
                                         -28-

[*28] the property produced under federal income tax principles." Sec. 1.263A-

2(a)(1)(ii)(A), Income Tax Regs.

      Mr. Ashkouri's testimony regarding the projects he pursued was not

particularly detailed, but we take him as having acknowledged that, had he been

awarded any of the projects, he would have acquired an ownership interest in the

property being developed. He did not identify any project for which he claimed

deductions in which he would not have received an ownership interest had he been

awarded the contract.11

      Thus, we accept petitioners' argument that Mr. Ashkouri was not required

by section 263A to capitalize his expenses of pursuing any project that did not

result in his acquiring an interest in property.12 But petitioners' argument does not


      11
         Sec. 263A might not apply to any costs Mr. Ashkouri incurred in pursuing
the Russian Federation project. We find no evidence in the record of any
relationship between Mr. Ashkouri and Noorland-Ltd., the party identified in the
business plan as the development's "owner", other than their potential joint
participation in that project. But the record does not establish what portion of the
payments Mr. Ashkouri made to ARCADD, if any, was for the Russian Federation
project. Moreover, if, as petitioners claim, ARCADD prepared the business plan
and received payment therefor directly from Mr. Sagdiev, it would not have been
entitled to compensation from Mr. Ashkouri for its work.
      12
        Respondent observes that this Court "has specifically held that architect's
fees must be capitalized under I.R.C. § 263A if I.R.C. § 263A applies." To the
extent that the cases respondent cites in support of that observation involved
architect's fees, however, they required the capitalization of fees paid for plans for
                                                                         (continued...)
                                        -29-

[*29] establish that the expenses in issue were immediately deductible. We

conclude that those expenses are governed by section 1.263A-1(e)(3)(ii)(T),

Income Tax Regs., and thus are not covered by the exemption for marketing costs

provided by section 1.263A-1(e)(3)(iii)(A), Income Tax Regs. Section 1.263A-

1(e)(3)(ii)(T), Income Tax Regs., required the deferral of those costs pending the

outcome of the bidding process. And petitioners have not met their burden of

proving that those initially deferred costs became deductible during any of the

years in issue. Mr. Ashkouri was, for the most part, unsuccessful in his pursuit of

the various projects in regard to which he claims to have paid ARCADD for

marketing materials. (The payments made by Mr. Sagdiev in regard to the Russian

Federation project were only for a business plan; Mr. Ashkouri was not awarded a

contract to develop property in Russia.) But petitioners have not established when

(if ever) the development contracts Mr. Ashkouri sought were awarded to others,

when Mr. Ashkouri received written notice that no contract would be awarded, or

when he abandoned his bid or proposal for each project.




      12
        (...continued)
the development of property owned by the taxpayer. See Von-Lusk v.
Commissioner, 104 T.C. 207 (1995); Ohana v. Commissioner, T.C. Memo. 2014-
83. Those cases thus do not establish that fees paid for architectural drawings
used in the unsuccessful pursuit of development projects must also be capitalized.
                                        -30-

[*30] Even if we were to accept that the expenses in issue were not subject to

deferral under section 1.263A-1(e)(3)(ii)(T), Income Tax Regs., we would still

conclude that respondent properly disallowed the deductions for architectural or

contract services claimed on the Schedules C for Mr. Ashkouri's proprietorship

because petitioners did not adequately substantiate the expenses underlying the

claimed deductions. In general, section 162(a) allows a deduction for "all the

ordinary and necessary expenses paid or incurred during the taxable year in

carrying on any trade or business". When called upon by the Commissioner,

however, a taxpayer must substantiate his expenses. See, e.g., Park v.

Commissioner, T.C. Memo. 2012-279, at *4; see also sec. 6001; sec. 1.6001-1(a),

Income Tax Regs. To meet that burden, the taxpayer must substantiate both "the

amount and purpose of the claimed deduction." Higbee v. Commissioner, 116

T.C. 438, 440 (2001). The documentation petitioners provided to substantiate the

claimed deductions for architectural or contract services establishes only the

making of deposits (sometimes by Mr. Ashkouri) to ARCADD's bank accounts.

As respondent observes concerning that documentation, "there is nothing linking

the specific deposits to a reason why they are being made (i.e. specific work that

was done by ARCADD to generate the payment due, a specific invoice, bill, etc.)."

And respondent is also correct that, in regard to most of the deposits, "there is no
                                        -31-

[*31] documentation in the record establishing that petitioners were the source of

funds for the deposits."

      The rule established in Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d

Cir. 1930), allows us to estimate the amounts of allowable deductions when there

is evidence that the taxpayer incurred deductible expenditures. To do so, however,

we must have some basis on which to make an estimate. Vanicek v.

Commissioner, 85 T.C. 731, 742-743 (1985). We accept that Mr. Ashkouri's

pursuit of development projects required the preparation of proposed designs and

other materials to demonstrate to prospective clients how he and his affiliates

would pursue the project if selected. But we find insufficient evidence in the

record to make even a rough estimate of what the necessary materials might cost.

Therefore, even if petitioners had established that the costs of any "marketing"

materials for which Mr. Ashkouri paid ARCADD were deductible when paid, we

would still uphold respondent's disallowance of petitioners' deduction of those

costs because they have neither adequately substantiated the amounts incurred nor

given us a reliable basis for estimating them.

      C.     Remaining "Other Expenses"

      In regard to the expenses other than those for architectural or contract

services reported on line 27 or 27a of the Schedule C for Mr. Ashkouri's
                                        -32-

[*32] proprietorship for each of the years in issue, the only argument petitioners

make in their opening brief is encompassed within the summary claim that they

"were entitled to claim Schedule C expenses in the amounts of $229,194, $104,

624 [sic] and $223,332 for the 2009, 2010 and 2011 tax years, respectively as was

demonstrated in our exhibits."

      We cannot be sure what exhibits petitioners have in mind. In their briefs,

they refer repeatedly to 14 "volumes" of three-ring binders that they provided to

respondent to substantiate the Schedule C deductions in issue. Respondent

stipulated his receipt of those documents, but the documents themselves were not

attached to the parties' stipulation. Petitioners accuse respondent of having

"WITHHELD EVIDENCE", thereby "misleading * * * the Honorable Court". But

respondent merely declined to stipulate the material in petitioners' volumes.

Petitioners made no effort to introduce on their own those materials which

respondent declined to stipulate. The only document petitioners introduced on

their own is an apparently unfiled amended return for only one of the years in

issue that reports Schedule C expenses for Mr. Ashkouri's proprietorship in the

same amounts as the 2011 return petitioners actually filed. An amended return,

whether or not filed, that reports the same deductions claimed on an originally

filed return cannot serve as substantiation for those deductions.
                                        -33-

[*33] In short, petitioners offer us no meaningful argument to contest respondent's

claim that they have not adequately substantiated the remaining amounts (in

addition to payments for architectural or contract services) reported on line 27 or

27a of the Schedule C for Mr. Ashkouri's proprietorship for each of the years in

issue. Their brief cites no authority on what constitutes adequate substantiation

and includes no clear references to substantiating evidence in the record. We will

thus treat petitioners as having conceded that they are not entitled to deduct the

remaining other expenses.

III.   Schedule C Meals and Entertainment

       In regard to the expenses for meals and entertainment reported on the

Schedules C for Ashkouri's proprietorship for the years in issue, petitioners claim

in their opening brief: "Petitioner Ashkouri included the restaurant receipts in his

submission to the Respondent's counsel and the Honorable court." They do not

advise us where in the record we can find those receipts. They conclude their

argument (such as it is) by complaining about respondent's questioning of the

relatively small expense reported for 2009:

       Petitioner Ashkouri finds it hard to understand that the annual
       expense for 2009 on meals of $49 was being questioned by the
       Respondent, when Petitioners and their staff were working tirelessly
       on completing CSG work, marketing in the USA and abroad. The
       same should also be accounted for 2010 and 2011 where ARCADD
                                         -34-

[*34] was also working on the Federal Way Projects, the Salt Lake City
      Project, as well as the projects in Russia and Libya. Petitioner have
      [sic] produced and delivered to Respondent, [sic] exhibits with 100%
      accurate detailed expenses.

      But respondent did not disallow the claimed deductions for meals and

entertainment expenses because the expenses were unreasonable in amount; he

disallowed them because, he contends, petitioners did not provide adequate

substantiation for them. And petitioners have given us no reason to conclude

otherwise.

      Again, petitioners' opening brief offers us no meaningful argument

challenging respondent's disallowance of the deductions in issue. We will thus

treat petitioners as having conceded that they are unable to adequately substantiate

the expenses for meals and entertainment reported on the Schedules C for Mr.

Ashkouri's proprietorship for the years in issue.

      Even if we did not treat petitioners as having conceded their failure of

substantiation and instead undertook our own search of the record for adequate

substantiation, we would not find evidence sufficient to meet the applicable

standard. Section 274(d) imposes heightened substantiation requirements for

deductions or credits for traveling expenses, expenses for gifts, amounts with

respect to "listed property", and items "with respect to an activity which is of a
                                         -35-

[*35] type generally considered to constitute entertainment, amusement, or

recreation, or with respect to a facility used in connection with such an activity".

To meet those requirements, a taxpayer must

      substantiate[] by adequate records or by sufficient evidence
      corroborating the taxpayer's own statement (A) the amount of such
      expense or other item, (B) the time and place of the travel,
      entertainment, amusement, recreation, or use of the facility or
      property, or the date and description of the gift, (C) the business
      purpose of the expense or other item, and (D) the business
      relationship to the taxpayer of persons entertained, using the facility
      or property, or receiving the gift. * * *

Id.

      The evidence we find in the record documenting the expenses for meals and

entertainment reported on the Schedules C for Mr. Ashkouri's proprietorship for

the years in issue does not meet the standards of section 274(d). We find no

documentary evidence at all of the expenses reported for 2010. And the evidence

submitted in regard to the other years does not establish the business purpose

served by the expenditures.

      We thus conclude that respondent properly disallowed the deduction of the

expenses for meals and entertainment reported on the Schedules C for Mr.

Ashkouri's proprietorship for the years in issue.
                                         -36-

[*36] IV.    Schedule C Travel Expenses

      Regarding the deductibility of the reported travel expenses, petitioners

claim to have "presented * * * part of the Discover Card expenses the vast sums of

money paid for travel to Russia and Libya to the British Airways, not to forget the

cost of visas, runners for obtaining the visas in Washington, DC." Again,

however, they neglect to tell us where in the record we can find the documentation

they claim to have presented. The balance of what passes for an argument on this

issue in their opening brief consists of further description of Mr. Ashkouri's

travel--but still with no references to evidence in the record supporting the

amounts of the claimed deductions.

      While those descriptions might indicate a business purpose for some of Mr.

Ashkouri's trips, statements in a party's briefs are not part of the evidentiary

record. See Rule 143(c) ("[S]tatements in briefs * * * do not constitute

evidence."); see also Veneziano v. Commissioner, T.C. Memo. 2011-160, 2011

WL 2637281, at *1 (disregarding testimonial statements included in a brief that

could not be readily sourced to the record). Mr. Ashkouri's opportunity to testify

was at trial; he cannot supplement that testimony on brief.

      Once again, because of petitioners' failure to advance a meaningful

argument, we will treat them as having conceded the issue. Moreover, as was the
                                         -37-

[*37] case in regard to the meals and entertainment expenses reported on the

relevant Schedules C, we would also hold against petitioners in regard to the travel

expenses even if we did not treat them as having conceded the issue but instead

undertook our own search of the record for adequate substantiation. Traveling

expenses, like those for meals and entertainment, are subject to the heightened

substantiation requirements of section 274(d). We find no evidence in the record

to substantiate the travel expenses reported for 2010, and the evidence submitted

in regard to the 2009 travel expenses does not establish the business purpose for

the expenses.

      We thus conclude that respondent properly disallowed the deductions of the

travel expenses reported on the Schedules C for Mr. Ashkouri's proprietorship for

the years in issue.

V.    Schedule C Office Expenses

      In regard to the deductibility of the office expenses reported on the

Schedules C for Mr. Ashkouri's proprietorship for the years in issue, petitioners

again attempt to testify through their opening brief, advising us:

      The Office expenses claimed by the Petitioners for Years 2009 in the
      amount of $1,775 and 2010 at the amount of $5,021 were costs for
      office stationery, drawing ink for plotters, printers, printing paper for
      drawings, etc. These materials had to be bought to allow the
      Petitioner to explain his plans for these projects to the clients, staff at
                                         -38-

[*38] ARCADD and to its architectural and engineering consultants * * *.
      ARCADD's planning and execution of the business plan for the City
      of Noorland required constant production and documentation with
      electronic media sent to Russia and back.

      Again, factual assertions made by a party on brief are not part of the

evidentiary record. Parties can--indeed, are required to--make proposed findings

of fact, but those proposals must be grounded in the record. Petitioners' opening

brief includes no references to evidence in the record to support the amount of

office expenses reported or the business justification for their incurrence.

      Once again, we will treat petitioners as having conceded the issue by reason

of their failure to advance a meaningful argument in their opening brief

challenging respondent's denial of the claimed deductions. And once again, were

we instead to consider the issue on the merits and conduct our own search of the

record for evidence sufficient to substantiate those deductions, our search would

prove unsuccessful. The documentation petitioners submitted to support the office

expense reported on the 2009 Schedule C for Mr. Ashkouri's proprietorship does

not indicate the relationship between the expense and the proprietorship's

business. And we find no evidence at all concerning the office expense reported

for 2010. In fact, in their reply brief, petitioners admit that "Ashkouri is not sure

how Mr. Rogers arrived at $5,021 expense * * * for 2010."
                                        -39-

[*39] We thus conclude that respondent properly disallowed the deductions of the

office expenses reported on the Schedules C for Mr. Ashkouri's proprietorship for

2009 and 2010.

VI.   State Tax Refunds

      A.     Introduction

      Taxpayers are required to include State tax refunds in their Federal taxable

income only to the extent of any tax benefit they realized from their prior

deduction of the State taxes in question. Section 111(a) provides: "Gross income

does not include income attributable to the recovery during the taxable year of any

amount deducted in any prior taxable year to the extent such amount did not

reduce the amount of tax imposed by this chapter."

      In 2010, Mr. Ashkouri received a refund of $5,225 of Massachusetts income

tax paid during 2009 and included in the amount of State income tax reported on

Schedule A of petitioners' 2009 Form 1040. And in 2011, Mr. Ashkouri received

a refund of $5,000 of Massachusetts income tax paid during 2010. The copy of

petitioners' 2010 Federal return included in the record does not provide sufficient

detail to determine that the $5,000 Massachusetts refunded in 2011 was included

in the larger sum deducted on petitioners' 2010 Schedule A. The supplementary

statements attached to petitioners' 2011 Federal return, however, support an
                                         -40-

[*40] inference that the $5,000 refunded in 2011 was included in the amount

deducted the previous year. (Those statements indicate that petitioners got no tax

benefit from having deducted the amount refunded--not that the amount refunded

was not deducted in the first place.) And petitioners provide us no reason to

interpret the statements otherwise. Therefore, petitioners must include the

amounts refunded in each of 2010 and 2011 in their taxable income for the year

except to the extent that the inclusion of the refunded amount on the preceding

year's Schedule A did not reduce their tax liability for the earlier year.

      We see no legal or factual issue for us to decide in regard to Mr. Ashkouri's

Massachusetts income tax refunds. The proper treatment of those refunds appears

to be purely computational. The extent to which petitioners' Federal income tax

liability was reduced by reason of the later-refunded State income tax depends on

the extent to which we uphold respondent's adjustment to petitioners' taxable

income for each year in which the refunded amount was reported on their

Schedule A.

      B.      2010

      As far as we can tell, petitioners claim they received no Federal tax benefit

from including on their 2009 Schedule A the Massachusetts income tax refunded

to Mr. Ashkouri in 2010. As they articulate their claim: "For Tax Year 2010,
                                         -41-

[*41] RSA [Rogers, Suleski & Associates, LLC, Mr. Rogers' accounting firm]

filed (0) Zero refund as their calculations of prior years of Alternative Minimum

Tax '(AMT') [sic] statements 1 and 2 as attached to this Petitioner's Response

showing that after calculating the AMT, the amount to be reported to the IRS in

terms of State Tax Refund was (0) zero." We are not sure what statements

petitioners refer to. The copy of their 2010 Federal income tax return stipulated

by the parties does not include any supplementary statements. But petitioners'

2009 Form 1040 reports AMT on line 45. And State income tax is not deductible

in computing the alternative minimum taxable income on which the AMT is

based. Sec. 56(b)(1)(A)(ii).

      Respondent acknowledges that "petitioners reported an AMT liability on

their 2009 Tax Return" but adds: "[I]t is unclear whether petitioners are liable for

the AMT for the 2009 tax year after taking into account adjustments made

pursuant to a Court opinion in this case, and whether the AMT negates the entire

tax benefit received by petitioners for their deductions claimed for state tax paid."

Respondent thus allows that petitioners should be required to include in income

the refund of 2009 State income tax that Mr. Ashkouri received in 2010 only "if

computations so provide".
                                         -42-

[*42] C.     2011

      By contrast, respondent asserts that the proper treatment of the refund of

Massachusetts income tax Mr. Ashkouri received in 2011 does not depend on the

extent to which we uphold his adjustments to petitioners' 2010 taxable income and

thus is not computational. According to respondent, petitioners must "report as

income * * * the state income tax refund that Ashkouri received during [the] 2011

tax year * * * since petitioners received a tax benefit for the payment of * * * [the

tax that was] subsequently returned to Ashkouri and thus not actually paid."

      Petitioners appear to make the same argument in regard to Mr. Ashkouri's

2011 refund as the one quoted above in regard to his 2010 refund. Immediately

after addressing the 2010 refund, they assert: "The same was calculated for Tax

Year 2011, RSA filed (0) Zero refund as their calculations of prior years of AMT

statements 1 and 2 as attached to this Petitioners' Response showing that after

calculating the AMT the amount to be reported to the IRS in terms of state Tax

Refund was zero." The information reported on petitioners' returns for 2010 and

2011, however, does not justify their exclusion from their 2011 taxable income of

the full amount of the $5,000 refund of Massachusetts income tax Mr. Ashkouri

received in 2011.
                                         -43-

[*43] Statement 2 attached to petitioners' 2011 Federal return is ambiguous in

regard to the specific reason for excluding from their taxable income the full

$5,610 of State income tax refunds received in that year. The statement refers to

two possible reasons for the exclusion: the impact of the AMT or the prospect of

deducting sales tax in lieu of income tax in the year in which the refunded tax was

paid. See sec. 164(b)(5)(A) (allowing a taxpayer to deduct State and local general

sales tax in lieu of State and local income taxes).

      On the basis of their argument on brief, however, we will treat petitioners as

having conceded that they did not base their exclusion from their taxable income

of Mr. Ashkouri's 2011 refund on the prospect of having been able to deduct sales

taxes in lieu of income tax in 2010. As noted above, petitioners claim that the

amount of the exclusion was arrived at "after calculating the AMT".

      But the grounds claimed by petitioners for the exclusion do not justify it:

Their 2010 Form 1040 reports no AMT on line 45.

      Were we not to treat petitioners as having conceded that their exclusion

from taxable income of Mr. Ashkouri's 2011 refund was not attributable to sales

taxes, we would face a factual question of whether they paid a sufficient amount of

sales tax in 2010 to justify their exclusion of the full $5,000 refund of State

income tax Mr. Ashkouri received in 2011. The evidence before us, however,
                                         -44-

[*44] supports an inference that petitioners did not pay a sufficient amount of sales

tax in 2010 to justify that exclusion. For the availability of a sales tax deduction

under section 164(b)(5)(A) to have eliminated any benefit from deducting the

$5,000 of Massachusetts income tax refunded to Mr. Ashkouri in 2011, petitioners

would have to have paid sales taxes of at least $16,187. In that case, if they had

taken into account in computing their deduction under section 164(a) only the

Massachusetts income tax not later refunded, their sales tax paid of $16,187 would

have exceeded their net State income tax paid of $14,310 ($19,310 reported on

2010 Schedule A ! $5,000 refunded in 2010). Deducting sales tax instead of

income tax would have given them total itemized deductions of $71,233 ($74,356

total reported itemized deductions ! $19,310 State and local income tax + $16,187

sales tax). The excess of their AGI over their itemized deductions would have

equaled their exemptions ($78,533 reported AGI ! $71,233 revised itemized

deductions = $7,300 reported exemptions), leaving them with taxable income of

exactly zero. For every dollar that their sales tax was less than $16,187, they

would have gotten some benefit from having deducted for 2010 the $5,000 of

Massachusetts income tax refunded to Mr. Ashkouri in 2011.

      Respondent, who bears the burden of proof on this issue, did not introduce

evidence concerning the amount of sales tax petitioners paid in 2010. (Indeed, his
                                        -45-

[*45] briefs give no indication that he recognized the potential importance of that

question.) Nonetheless, we are willing to infer from evidence that is in the

record--in particular, the amounts petitioners reported on their 2010 Federal

income tax return--that they paid sales tax in 2010 of less than $14,310 (that is, the

excess of the $19,310 of State income tax reported on their 2010 Schedule A over

the $5,000 refund Mr. Ashkouri received from Massachusetts in 2011). Although

respondent did not ask us to make that inference, the available evidence so

strongly supports it that we will make it without his invitation. On the basis of

that inference, we would conclude (even without treating petitioners as having

made a concession to that effect) that the possibility of deducting sales tax instead

of income tax has no bearing on the extent to which their deduction of the later-

refunded amount either reduced their reported Federal income tax liability or

reduces the liability they are ultimately determined to owe.

      Massachusetts imposes a sales tax of 6.25%, Sales and Use Tax, Mass.gov,

https://www.mass.gov/guides/ sales-and-use-tax (last visited June 10, 2019)--a

rate that has been in effect since 2009, The Republican Newsroom, Mass. Sales

Tax Goes Up From 5% to 6.25% on Saturday, MassLive (July 31, 2009),

https://www.masslive.com/news/2009/07/mass_sales_tax_goes_up_ from_5.html

(last visited June 10, 2019). Paying $16,187 of sales tax would have required
                                        -46-

[*46] making expenditures subject to the tax of $258,992 ($16,187 ÷ 0.0625). By

contrast, the wage and investment income shown on petitioners' 2010 Federal

income tax return total only $253,256. In considering the amount of sales tax

petitioners might have paid in 2010, we have also consulted the sales tax

calculator that the Internal Revenue Service provides on its website in compliance

with a congressional mandate. See H.R. Conf. Rept. No. 108-755, at 449 (2004),

2004 U.S.C.C.A.N. 1341, 1516. The calculator estimates the sales tax paid by a

taxpayer for a given taxable year on the basis of average consumption patterns

State-by-State to obviate the need to maintain receipts of each purchase subject to

tax. Id. On the basis of petitioners' residence, AGI, and exemptions (and without

regard to large, nonrecurring purchases such as that of an automobile), the online

calculator estimates that petitioners paid sales tax in 2010 of only $653. See IRS

Sales Tax Deduction Calculator, https://apps.irs.gov/app/stdc/stdc.html (last

visited June 10, 2019).

      Although the information reported on petitioners' 2010 Federal income tax

return does not justify their exclusion, for 2011, of the full amount of the $5,000

income tax refund Mr. Ashkouri received from Massachusetts in that year, it did

justify their exclusion of most of that refund. The sum of the itemized deductions

reported on petitioners' 2010 return and their exemption amount ($74,356 +
                                        -47-

[*47] $7,300 = $81,656) exceeds their reported AGI of $78,533 by $3,123.

Therefore, reducing their itemized deductions by $5,000 would have created only

$1,877 of taxable income ($5,000 ! $3,123). Thus, the proper treatment of Mr.

Ashkouri's 2011 refund, like that of his 2010 refund, is a matter of computation

pending our resolution of the issues respondent raised for petitioners' 2010 tax

year. Nonetheless, from what we have said already, we can conclude that

petitioners' taxable income for 2010 will be reduced by the full $5,000 of

Massachusetts income tax included in the amount reported on their 2010 Schedule

A and refunded to Mr. Ashkouri in 2011. We have concluded that petitioners did

not properly substantiate any of the $160,987 of expenses reported on the 2010

Schedule C for Mr. Ashkouri's proprietorship. Thus, petitioners' 2010 taxable

income, after taking into account our resolution of the issues before us, will far

exceed $5,000.

      We thus conclude that petitioners are required to include in their 2011

taxable income the full amount of the $5,000 refund of Massachusetts income tax

Mr. Ashkouri received in that year. They will be required to include Mr.

Ashkouri's 2010 refund in their taxable income for that year only to the extent that

the calculations prepared under Rule 155 following our issuance of this opinion

demonstrate that the inclusion of the amount refunded in 2010 in the amount
                                         -48-

[*48] reported on petitioners' 2009 Schedule A reduced their Federal income tax

liability for that year.

VII. Payments for Russian Federation Project Business Plan

       In the amendment to his answer, respondent alleges: "Petitioners failed to

report on their 2010 Tax Return * * * gross receipts in the amount of $69,798

* * * earned by Ashkouri's Schedule C business during the 2010 tax year." The

amount of the alleged omission is the sum of the two wire transfers made by Mr.

Sagdiev to ARCADD's bank account in June and July 2010. Respondent contends

that Mr. Ashkouri was entitled to the payments in issue and should be treated as

having received the payments as income (and then, presumably, as having

transferred them to ARCADD as capital contributions).

       In their opening brief, petitioners address the issue concerning the payments

by Mr. Sagdiev as follows: "What the Respondent is stating amounts to Ashkouri

committing fraud. This thought was extremely disturbing to Petitioner Ashkouri

as it was the Respondent was attempting to move him to declare income that was

not his. Petitioner Ashkouri had a fiduciary responsibility towards ARCADD,

Inc., its staff, its clients and Federal and State Governments." In the final portion

of their brief, under the heading "Conclusions", petitioners state: "The $69,794

two payments from Russian Federation were ARCADD's and not Ashkouri's."
                                        -49-

[*49] Although petitioners fail to cite any evidence in the record in support of

their claim that ARCADD, rather than Mr. Ashkouri, was entitled to the payments

in issue, we will accept the claims they make in their opening brief as sufficient to

avoid treating them as having conceded the issue. Instead, we will treat the issue

as turning on the resolution of a factual dispute: whether ARCADD or Mr.

Ashkouri was entitled to the payments made by Mr. Sagdiev. Because respondent

raised the issue by amendment to his answer, he bears the burden of proof on the

determinative factual question. For the reasons explained below, we conclude that

he has not met that burden.

      The record (including the business plan itself) makes it clear that ARCADD

and "Hisham Ashkouri, Architects" were both involved in the Russian Federation

project. Their joint pursuit of the project is consistent with Mr. Ashkouri's

description of the respective roles of ARCADD and his proprietorship. He sought

to act as developer in his individual capacity, while ARCADD provided

architectural and design services. Because the business plan includes proposed

plans and designs, we accept that ARCADD was involved in its preparation. The

question at hand is whether ARCADD worked on the business plan as a

subcontractor of Mr. Ashkouri or pursuant to a direct relationship with Mr.

Sagdiev. (Conversely, to the extent that Mr. Ashkouri himself was involved in the
                                        -50-

[*50] preparation of the business plan, he could have done so either in his own

right as a proprietor or instead as an employee of ARCADD.)

      Under the circumstances, we expect that Mr. Sagdiev was indifferent to the

questions of contractual privity that will determine the proper U.S. Federal income

tax treatment of the payments he made. And we accept that, at least setting taxes

aside, Mr. Ashkouri might have had little reason to scrupulously document the

legal relationship between his proprietorship and the corporation. The parties'

possible indifference to legal niceties would have been a problem for petitioners if

they had borne the burden of proof on the issue at hand. Instead, it is respondent

who faces that problem.

      Some of the evidence on which respondent relies merely establishes Mr.

Ashkouri's involvement, as proprietor, in the Russian Federation project. But Mr.

Ashkouri--for the most part--does not deny his involvement. He admitted that he

sought to serve as the project's developer.13 The question, again, is whether


      13
        Respondent makes much of the fact that, when asked on cross-examination
whether his "Schedule C was uninvolved in the Russian project", Mr. Ashkouri
answered "absolutely". But that brief exchange is contradicted by other testimony
by Mr. Ashkouri and by documentary evidence. Mr. Ashkouri's ready agreement
with the assertion by respondent's counsel may have reflected understandable
confusion about counsel's personification of a Federal income tax form. In other
testimony, Mr. Ashkouri acknowledged his interest in serving as the project's
                                                                     (continued...)
                                        -51-

[*51] ARCADD or Mr. Ashkouri, as proprietor, was entitled to the consideration

Mr. Sagdiev paid for the business plan. In other words, did Mr. Ashkouri direct

Mr. Sagdiev to wire the funds to ARCADD's account because ARCADD was

entitled to the consideration, or did Mr. Ashkouri, in directing to ARCADD

payments to which he was entitled individually, in effect make capital

contributions to ARCADD?

      Respondent also relies on petitioners' responses to discovery requests that

can be read to indicate that Mr. Ashkouri himself was entitled to the payments for

the business plan. Respondent insinuates that Mr. Ashkouri changed his tune at

trial to avoid being subject to tax on the payments in issue. But respondent did not

seek to amend his answer to (among other things) assert an omission of Russian

Federation project income until December 2016--several months after petitioners

had corrected their earlier statements about the destination of the funds wired by

Mr. Sagdiev. Therefore, petitioners' inconsistencies regarding the entitlement to

the Russian Federation project income cannot be attributed entirely to changing

tax stakes.




      13
       (...continued)
developer. And the business plan itself makes clear the involvement of Mr.
Ashkouri's proprietorship in the pursuit of the Russian Federation project.
                                        -52-

[*52] The inconsistencies in Mr. Ashkouri's trial testimony concerning the

entitlement to the income from the Russian Federation project may reflect an

understandable degree of casualness in differentiating between himself and his

wholly owned corporation. When the questions posed to him made that

distinction clear, Mr. Ashkouri consistently testified that ARCADD prepared the

business plan and thus appropriately received payment for it.

      Respondent also observes that ARCADD did not report the June 2010 wire

transfer as fee revenue on its books or tax return for the year ended June 30, 2010.

But respondent seems unaware that the evidence on which he relies establishes

that ARCADD did report its receipt of the June wire transfer on both its books and

tax returns, although not as fee revenue. Moreover, no such mischaracterization

occurred in regard to the July 2010 wire transfer. The documentation petitioners

provided to respondent shows that ARCADD included the amount of that transfer

in the fee revenue it reported for both book and tax purposes for the year ended

June 30, 2011.

      In the face of conflicting evidence concerning the identity of the party

entitled to payment for the Noorland-Ltd. business plan, we conclude that

respondent has not met his burden of proving that petitioners should have included

Mr. Sagdiev's payments in their taxable income for 2010. The Court found Mr.
                                         -53-

[*53] Ashkouri to be a credible witness. When forced to distinguish between his

role as proprietor, on the one hand, and his role as officer and sole shareholder of

ARCADD, on the other, Mr. Ashkouri testified that ARCADD prepared the

business plan. Because the preparation of the business plan required design work,

Mr. Ashkouri's claim is consistent with his description of the roles of his

proprietorship's and ARCADD's businesses. To the extent that some of

petitioners' responses to discovery requests conflict with Mr. Ashkouri's testimony

at trial, those inconsistencies may be explained either by faulty recollection--

corrected after examination of the relevant documents (and before respondent

amended his answer to assert unreported income)--or, again, a certain casualness

in distinguishing among the roles Mr. Ashkouri filled in his various, interrelated

business ventures.

VIII. Gain From Sale of 1188 Beacon Street, Unit B

      A.     Introduction

      Petitioners reported CSG's sale of Unit B on their 2011 Federal income tax

return on the premise that the property was "used in * * * [a] trade or business".14

      14
         Neither party claims that petitioners' consistent reporting of CSG's
activities on their individual joint returns was incorrect. Moreover, at trial, the
parties agreed that CSG was properly disregarded as an entity separate from Mr.
Ashkouri, its sole member. Therefore, we assume that CSG made no election
                                                                         (continued...)
                                         -54-

[*54 ] See sec. 1231(a)(3)(A) (defining "section 1231 gain" to include "any

recognized gain on the sale or exchange of property used in the trade or

business"). Section 1231(a)(1) provides: "If--(A) the section 1231 gains for any

taxable year, exceed (B) the section 1231 losses for such taxable year, such gains

and losses shall be treated as long-term capital gains or long-term capital losses, as

the case may be."

      B.     Character of Gain

      In the amendment to his answer, respondent claims that "petitioners

mischaracterized the nature of their gain from the sale of Unit B." The argument

he makes in support of that claim, however, is somewhat misplaced. Respondent

appears to rest his argument on the contention that Unit B is not a capital asset.

Petitioners, as we understand them, would not disagree. As noted above, their

reporting of CSG's sale of Unit B reflects the premise that the property was "used

in the trade or business", so that the gain from its sale was "section 1231 gain", as

defined by section 1231(a)(3)(A). Thus, they reported the gain from CSG's sale of

Unit B as long-term capital gain not by reason of section 1222(3), which defines

      14
        (...continued)
under sec. 301.7701-3(c), Proced. & Admin. Regs., to be classified as a
corporation. See sec. 301.7701-3(b)(1)(ii), Proced. & Admin. Regs. (providing
that a domestic LLC that has a single owner is disregarded as an entity separate
from that owner in the absence of an election to the contrary).
                                         -55-

[*55] "long-term capital gain" to mean recognized gain from the sale of a capital

asset held for more than one year, but instead by reason of section 1231(a)(1).

Petitioners' reporting therefore rests on the premise that Unit B was not a capital

asset. See sec. 1221(a)(2) (excluding from the definition of "capital asset"

"property * * * used in * * * [a taxpayer's] trade or business, of a character which

is subject to the allowance for depreciation provided in section 167, or real

property used in his trade or business").15

      Thus, the issue in contention is not whether Unit B was a capital asset but

instead whether it was property used in CSG's (and therefore Mr. Ashkouri's)

business. Neither party directly addresses that question. But respondent bases his

argument that Unit B was not a capital asset on the contention that CSG held the

property "for sale to customers in the ordinary course of * * * [its] trade or

business." If respondent's claim were correct, not only would Unit B be excluded

from the definition of "capital asset", see sec. 1221(a)(1), but it would also not




      15
        We base our understanding of petitioners' position primarily on their
return because their briefs offer little, if any, additional elucidation. In their
opening brief, they advise us: "The profit of $15,945 from the sale of Unit 1188B
of CSG sold in 2011 was reported as zero ($0.00) as Rogers calculated the
$15,945 through Schedule A-Net Operating Loss (NOL) of approximately
$21,567." They conclude: "Therefore, the Petitioners were not required to carry
the $15,945.00 in income from the sale of Unit 1188B in their Schedule C."
                                        -56-

[*56] qualify as "property used in the trade or business" for purposes of section

1231, see sec. 1231(b)(1)(B).

      Petitioners offer us no explanation of why Unit B qualifies as "property

used in the trade or business" within the meaning of section 1231(b)(1). In fact,

their briefs make no reference at all to section 1231. Because they did not

challenge the proposed findings on which respondent bases his position that Unit

B was "held * * * primarily for sale to customers in the ordinary course of * * *

[Mr. Ashkouri's] business, we so find."16 Cf. sec. 1221(a)(1). We thus conclude

that Unit B was not "property used in the trade or business" within the meaning of

section 1231(b)(1) and was excluded from the definition of capital asset by section

1221(a)(1). It follows that the gain Mr. Ashkouri recognized (through CSG) from

the sale of Unit B was ordinary income and not capital gain.




      16
        Petitioners explicitly agreed to all but one of the other proposed findings
on which respondent relies. The one they did not explicitly agree to, as reflected
in our Findings of Fact, relates to CSG's hiring of subcontractors, including
ARCADD. Petitioners responded to that proposed finding only by observing:
"Copies of contracts were provided to Respondent." Because petitioners' response
does not state grounds for objecting to respondent's proposed finding, we treat
them as having agreed to it. See Estate of Ballantyne v. Commissioner, T.C.
Memo. 2002-160, 2002 WL 1359741, at *1 n.3, aff'd, 341 F.3d 802 (8th Cir.
2003).
                                         -57-

[*57] C.     Amount of Gain

      As a general rule, this Court considers only issues raised by the parties'

pleadings. E.g., Markwardt v. Commissioner, 64 T.C. 989, 997 (1975). Departing

from that practice would frustrate the stated purpose of those pleadings, which is

"to give the parties and the Court fair notice of the matters in controversy and the

basis for their respective positions." Rule 31(a). Rule 41(b)(1), however, provides

an exception to that general rule, stating:

      When issues not raised by the pleadings are tried by express or
      implied consent of the parties, they shall be treated in all respects as if
      they had been raised in the pleadings. The Court, upon motion of any
      party at any time, may allow such amendment of the pleadings as may
      be necessary to cause them to conform to the evidence and to raise
      these issues, but failure to amend does not affect the result of the trial
      of these issues.

      On brief, respondent "takes the position * * * that income from the sale of

1188, Unit B was [not only mischaracterized but] also underreported in that the

basis determined by Rogers was erroneously inflated." Respondent acknowledges

that the issue of Unit B's proper basis was "not raised in the pleadings". But he

purports in his opening brief to move, under Rule 41(b), "to amend the pleadings

to conform to the evidence to assert unreported Schedule C gross receipts in the

amount of $410,787 for the 2011 tax year."
                                          -58-

[*58] We disagree with respondent that the issue of Unit B's basis was tried by the

parties' consent. Respondent's answer, even after amendment, raised only the

question of the character of the gain, accepting that its amount was $15,945, as

reported on petitioners' 2011 Form 4797 and Schedule D of Form 1040. Similarly,

respondent's pretrial memorandum identifies as an issue only the character of the

gain and not its amount. No mention was made during trial of the amount of the

gain. Therefore, we find it unsurprising that petitioners' opening brief

acknowledged no issue concerning the amount of Unit B's basis. Respondent

raised that issue for the first time in his opening brief.

      In support of his position on the merits, respondent relies entirely on the

email exchange prompted by Mr. Rogers' request of Mr. Ashkouri for an

"approximate cost basis" for Unit B. The stipulation of facts with which the

parties submitted that email exchange gives no indication of the exchange's

intended import. We do not take the inclusion of evidence of Mr. Ashkouri's

initial estimate of Unit B's basis as consent to try the issue of whether the amount

later reported on petitioners' 2011 return was overstated. If petitioners had

understood that respondent sought to challenge the reported basis, they might have

introduced additional evidence in support of the calculations by Mr. Rogers

underlying that amount.
                                         -59-

[*59] Accordingly, the issue of CSG's basis in Unit B (and thus the amount of

gain recognized upon the sale of the property) is not properly before us, and we

decline to consider it.

IX.   Accuracy-Related Penalties

      Section 6662(a) and (b)(2) provides an accuracy-related penalty of 20% on

the portion of an underpayment of tax attributable to "[a]ny substantial

understatement of income tax." Section 6662(d)(2)(A) defines the term

"understatement" as the excess of the tax required to be shown on the return over

the amount shown on the return as filed. In the case of an individual, an

understatement of tax is "substantial" if it exceeds the greater of 10% of the tax

required to be shown on the return or $5,000. Sec. 6662(d)(1)(A). An

understatement is reduced, however, by the portion attributable to the treatment of

an item for which the taxpayer had "substantial authority" or, in the case of items

adequately disclosed, a "reasonable basis". Sec. 6662(d)(2)(B). A taxpayer's

position has substantial authority if the weight of the authorities in support of that

position is substantial in relation to the weight of any contrary authorities. See

sec. 1.6662-4(d)(3), Income Tax Regs. Disclosure is adequate if it includes "the

relevant facts affecting the item's tax treatment". Sec. 6662(d)(2)(B)(ii)(I).

Subject to exceptions provided in an annual revenue procedure, disclosure must be
                                         -60-

[*60] made on Form 8275 or, in the case of positions contrary to a regulation,

Form 8275-R, Regulation Disclosure Statement. Sec. 1.6662-4(f)(1) and (2),

Income Tax Regs. The "reasonable basis" standard is "a relatively high standard

of tax reporting" that generally requires a position to be "reasonably based" on

relevant authorities. See sec. 1.6662-3(b)(3), Income Tax Regs.

      Section 6664(c)(1) provides an exception to the imposition of the section

6662(a) accuracy-related penalty if it is shown that there was reasonable cause for

the underpayment and the taxpayer acted in good faith. As a general rule, "[t]he

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." Sec. 1.6664-4(b)(1), Income Tax Regs. In making that

determination, "the most important factor" is usually "the extent of the taxpayer's

effort to assess the taxpayer's proper tax liability." Id. Reliance on the advice of a

professional tax adviser may constitute reasonable cause and good faith "if, under

all the circumstances, such reliance was reasonable and the taxpayer acted in good

faith." Id. As we observed in Neonatology Assocs., P.A. v. Commissioner, 115

T.C. 43, 100 (2000), aff'd, 299 F.3d 221 (3d Cir. 2002), however, "[t]he mere fact

that a certified public accountant has prepared a tax return does not mean that he

or she has opined on any or all of the items reported therein."
                                         -61-

[*61] The Commissioner bears the burden of production with respect to penalties.

See sec. 7491(c). To meet that burden, he must establish the appropriateness of

imposing the penalty either through the production of evidence or reliance on

concessions by the taxpayer. Higbee v. Commissioner, 116 T.C. at 446; Oria v.

Commissioner, T.C. Memo. 2007-226, 2007 WL 2318367, at *4. The

Commissioner's burden of production under section 7491(c) includes establishing

compliance with the requirement of section 6751(b) that the "initial determination"

to assess a penalty be "personally approved (in writing) by the immediate

supervisor of the individual making such determination or such higher level

official as the Secretary may designate." Graev v. Commissioner, 149 T.C. 485,

493 (2017), supplementing and overruling in part 147 T.C. 460 (2016). Once the

Commissioner carries his burden of production, taxpayers bear the burden of

proving that they are entitled to relief under section 6664(c)(1) or on the basis of

substantial authority or adequate disclosure. See Higbee v. Commissioner, 116

T.C. at 446.

      Respondent has established that, without regard to section 6662(d)(2)(B),

petitioners substantially understated their income tax for 2009. For the reasons

explained above, we are upholding all of the adjustments respondent made to

petitioners' 2009 taxable income in the notice of deficiency. And, in regard to that
                                        -62-

[*62] year, respondent no longer asserts any further adjustments.17 Therefore, the

amount of tax petitioners were required to show on their 2009 Federal income tax

return is the "total corrected tax liability" of $183,975 shown for 2009 on the Form

5278 attached to the notice of deficiency. Petitioners' 2009 return reported a total

tax of $112,148, resulting in a potential understatement of $71,827 ($183,975 !

$112,148). That understatement would be "substantial", within the meaning of

section 6662(d)(1)(A), because it exceeds 10% of the tax required to be shown on

their 2009 return ($18,398, which, in turn, is greater than $5,000).

      Respondent has also established that, again without regard to section

6662(d)(2)(B), petitioners substantially understated their income tax for 2010 and

2011. The precise amounts of petitioners' deficiencies for 2010 and 2011 as a

result of our disposition of the issues addressed above have yet to be determined.

See Rule 155. Nonetheless, because we are upholding all of the adjustments

respondent made in the notice of deficiency for each of 2010 and 2011, the

amount of tax required to be shown on their returns for those years will at least

equal the "total corrected tax liability" for the year shown on the Form 5278




      17
         As explained above, see supra note 1, although respondent asserted by
amendment to his answer that petitioners omitted from their 2009 taxable income
a State income tax refund received in that year, he abandoned that claim on brief.
                                        -63-

[*63] attached to the notice of deficiency.18 The Form 5278 shows a total

corrected tax liability for 2010 of $44,094, which is $44,009 greater than the $85

of total tax shown on petitioners' 2010 return. Because $44,009 is greater than

$5,000 (which, in turn, exceeds 10% of the minimum amount of tax petitioners

were required to show on their 2010 return), petitioners will have a substantial

understatement for 2010 as well unless they establish grounds for reduction of that

understatement under section 6662(d)(2)(B). The Form 5278 shows a total

corrected tax liability for 2011 of $69,930, which is $68,873 greater than the

$1,057 of total tax shown on petitioners' 2011 return. Because $68,873 is greater

than 10% of the minimum amount of tax required to be shown on petitioners' 2011

return (which, in turn, exceeds $5,000), petitioners will have a substantial

understatement for 2011--again, unless they can establish grounds for reduction of

that understatement under section 6662(d)(2)(B). Therefore, respondent has

      18
         The total amount of tax petitioners were required to report on their 2011
return will exceed the total corrected tax liability shown on the Form 5278 by
reason of our conclusions that (1) petitioners were required to include in their
2011 taxable income the $5,000 refund of Massachusetts income tax Mr. Ashkouri
received in that year and (2) the gain Mr. Ashkouri recognized through CSG from
the sale of Unit B was ordinary income and not capital gain. The total amount of
tax petitioners were required to report on their 2010 return will exceed the total
corrected tax liability shown on the Form 5278 if the parties' Rule 155
computations demonstrate that petitioners are required to include in their taxable
income for that year some or all of the refund of Massachusetts income tax that
Mr. Ashkouri received in that year.
                                         -64-

[*64] satisfied his burden of production in regard to the substantial understatement

penalties. Respondent has also satisfied his burden of production with regard to

the supervisory approval requirement of section 6751(b).

      Petitioners have not established that they are entitled to relief from the

accuracy-related penalties respondent determined. They make no claim under

section 6662(d)(2)(B) that they had either substantial authority or even a

reasonable basis for the treatment on their returns of the items subject to the

adjustments we have upheld. (Thus, the disclosure statement attached to their

return for each of the years in issue does not reduce their understatement for the

year.) Their opening brief does not address their liability for accuracy-related

penalties at all. In their reply brief, they assert that they "succeeded in establishing

defense to their case in Court", without articulating the basis of that defense. They

suggest, without specific reference to section 6664(c)(1), that they had reasonable

cause for their underpayments of tax and acted in good faith because of their

reliance on their return preparer. They claim to have "relied and trusted Mr.

Rogers and to this day believe in his honesty and integrity." But petitioners refer

us to no evidence in the record of specific advice Mr. Rogers gave them. Indeed,

we surmise from the disclosure statements that Mr. Rogers included in their
                                        -65-

[*65] returns that he warned petitioners of his doubts concerning the deductibility

of the largest of the Schedule C expenses in issue.

      For the reasons explained above, we conclude that petitioners are subject to

accuracy-related penalties under section 6662(a) for the years in issue.


                                               Decision will be entered

                                       under Rule 155.
