                          T.C. Summary Opinion 2014-97



                         UNITED STATES TAX COURT



ADEDAYO ALUBUNKUDI AND O. ADEDOTUN ALUBUNKUDI, Petitioners
     v. COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 18062-12S.                          Filed September 23, 2014.



      Adedayo Alubunkudi and O. Adedotun Alubunkudi, pro se.

      Kristina L. Rico, for respondent.



                              SUMMARY OPINION


      WHALEN, Judge: This case was heard pursuant to the provisions of

section 7463 of the Internal Revenue Code in effect when the petition was filed.

Pursuant to section 7463(b), the decision to be entered is not reviewable by any

other court, and this opinion shall not be treated as precedent for any other case.

Unless otherwise indicated, all section references are to the Internal Revenue Code
                                          -2-

in effect at all relevant times, and all Rule references are to the Tax Court Rules of

Practice and Procedure. Respondent determined tax deficiencies and section

6662(a) penalties for petitioners’ taxable years 2009 and 2010. The issue in this

case is whether petitioner and his spouse have substantiated the cost of goods sold

and certain deductions claimed on Schedules C, Profit or Loss From Business,

filed with their joint returns for an activity called OMA Enterprises.

       At the outset, we note that petitioner O. Adedotun Alubunkudi separated

from her husband approximately 18 months before trial, and she failed to take any

action to prepare this case for trial. She also failed to appear, in person or through

a representative, when this case was called for trial. As a result, the Court granted

respondent’s motion to dismiss petitioner O. Adedotun Alubunkudi for lack of

prosecution and ordered that a decision as to her would be entered in due course.

Accordingly, the only parties to the case at trial were Adedayo Alubunkudi

(petitioner) and respondent.

                                     Background

       The parties have stipulated some of the facts and the Court hereby takes the

stipulation of facts filed by the parties and the exhibits attached thereto into

evidence. Petitioner and his spouse resided in the State of New Jersey at the time

they filed their petition.
                                        -3-

      Petitioner and his spouse timely filed joint Forms 1040, U.S. Individual

Income Tax Return, for 2009 and 2010. Both returns stated that petitioner was a

“software engineer” and that his spouse was a “nurse.” The returns reported

aggregate wages of $190,008 and $175,442 for the years in issue, respectively.

The returns also reported net losses from four rental properties of $9,211 and

$3,646, respectively.

      The subject returns included Schedules C for OMA Enterprises on which

petitioner and his spouse reported net losses of $58,430 and $36,644, respectively.

The business of OMA Enterprises involved the purchase of damaged automobiles

and the restoration of those automobiles for resale. OMA Enterprises was

allegedly conducted solely by petitioner.

      The Schedules C for OMA Enterprises reported the following revenue and

expenses:

Schedules C for OMA Enterprises                2009               2010

      Gross receipts                          $16,854           $20,312

      Cost of goods sold                       57,850            23,294

      Gross profit                            -40,996             -2,982

      Other income                               -0-                -0-

      Gross income                            -40,996             -2,982
                                        -4-

      Advertising                                315                 431

      Car and truck expenses                   7,314              15,399

      Depreciation and sec. 179
       expense deduction                         -0-               4,595

      Legal and professional services          1,541               3,633

      Office expense                           3,161               4,813

      Supplies                                 4,623               4,311

      Other expenses (Internet)                  480                 480

      Total expenses                          17,434              33,662

      Net profit or (loss)                    -58,430            -36,644

      After reviewing the records for this activity submitted during the audit of

petitioner and his spouse’s returns, respondent determined in the notice of

deficiency, among other adjustments, that those records were “incomplete and

inadequate” to substantiate the cost of goods sold reported on the Schedules C.

Accordingly, respondent recomputed the gross profit from the activity by applying

industry averages (i.e., 24.03% for 2009 and 24.51% for 2010) to the gross

receipts reported. Respondent then determined the cost of goods sold by

subtracting the recomputed gross profit from gross receipts. The following

schedule shows that computation.
                                          -5-

                                                 2009             2010

            Gross receipts (per return)         $16,854         $20,312

            Gross profit percentage
             (industry average)                   24.03%           24.51%

            Recomputed gross profit              $4,050           $4,978

            Cost of goods sold (i.e.,           $12,804         $15,334
             gross receipts less
             recomputed gross profit)

In effect, respondent allowed costs of goods sold of $12,804 for 2009 and $15,334

for 2010. The amount disallowed for each year is computed as follows:

                                                 2009             2010

            Cost of goods sold
             (as reported)                      $57,850         $23,294

            Amount allowed                       12,804           15,334

            Amount disallowed                    45,046            7,960

      As to the deductions claimed on the Schedules C for OMA Enterprises,

respondent disallowed, for lack of substantiation, the deductions for car and truck

expenses, depreciation and section 179 expenses, legal and professional services,

and office expenses, in the aggregate amounts of $12,016 for 2009 and $28,440

for 2010. Respondent allowed the deductions claimed on each Schedule C for
                                               -6-

advertising, supplies, and Internet expenses, in the aggregate amounts of $5,418

for 2009 and $5,222 for 2010.

      In the notice of deficiency respondent determined total adjustments of

$75,523 to petitioner and his spouse’s return for taxable year 2009 and total

adjustments of $53,638 to their return for taxable year 2010. The adjustments

determined in the notice of deficiency are set forth below:

                                                      2009             2010

      Schedule E4 real estate loss after
       passive limitation                            $3,758   $1,414 Consequent adj.

      Schedule E3 real estate loss after
       passive limitation                             2,419     962 Consequent adj.

      Schedule E2 real estate loss after
       passive limitation                             1,453     571 Consequent adj.

      Schedule E1 real estate loss after
       passive limitation                             1,581     699 Consequent adj.

      Schedule C1 business selling reconditioned
       cars
        - Office expense                              3,161    4,813 Substantiation

        - Legal and professional expenses             1,541    3,633 Pet. conceded at trial

        - Car and truck expenses                      7,314   15,399 Substantiation

        - Cost of goods sold                         45,046    7,960 Substantiation

        - Depreciation and sec. 179 expense                    4,595 Substantiation

      Student loan interest deduction                 1,381     844 Consequent adj.

      Itemized deductions--home mortgage              7,869   10,748 Resp. concedes
        interest and points
                                         -7-
      Tuition and fees deduction                             2,000 Consequent adj.

          Total adjustments                    75,523       53,638

The decision in this case turns on the adjustments to the Schedules C that are

designated “Substantiation” in the above schedule.

                                     Discussion

      Generally, a taxpayer must show entitlement to any deduction claimed. See

INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992).1 A taxpayer may

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

carrying on a trade or business, but the taxpayer must maintain sufficient records

to substantiate the expenses claimed. Secs. 162(a), 6001; sec. 1.6001-1(a), Income

Tax Regs. The taxpayer bears the burden of substantiation. Hradesky v.

Commissioner, 65 T.C. 87, 89-90 (1975), aff'd, 540 F.2d 821 (5th Cir. 1976). This

requires the taxpayer to show the amount and purpose of any items claimed as

deductions. See id. Deductions are not allowed for personal, living, or family

expenses. Sec. 262(a).

      Section 274(d) imposes strict substantiation requirements for expenses

relating to, among other things, travel, entertainment, and “listed property”,


      1
        We need not discuss the burden-shifting provisions of sec. 7491(a)
because, in this case, there is nothing to suggest that those provisions apply, and
petitioner has made no claim that they do.
                                         -8-

including automobiles and other property used as a means of transportation. Sec.

280F(d)(4); sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014

(Nov. 6, 1985). To deduct such items, the taxpayer must substantiate “by [either]

adequate records or by sufficient evidence corroborating * * * [his] own

statement” the amounts of such expenses, their business purpose, and the business

relationship to the taxpayer of the person using the property. Sec. 274(d); Beale v.

Commissioner, T.C. Memo. 2000-158; sec. 1.274-A(b)(1), Income Tax Regs. To

meet the “adequate records” test a taxpayer must maintain an account book, a

diary, a log, a statement of expense, trip sheets, or similar records prepared

contemporaneously with the expenditure, and documentary evidence of certain

expenditures, such as receipts or bills. See sec. 1.274-5T(c)(2), Temporary

Income Tax Regs., 50 Fed. Reg. 46017 (Nov. 6, 1985). In combination, these

records must be sufficient to establish each element of the expenditure for which a

deduction is sought, i.e., amount, time and place, business purpose, and business

relationship.

      Cost of goods sold is an adjustment to gross income and is computed with

proper adjustment for opening and closing inventories for the year. See secs. 1.61-

3(a), 1.162-1(a), Income Tax Regs. Technically, it is not treated as a deduction

from gross income, and it is not subject to the limitations on deductions in sections
                                          -9-

162 and 274. See Metra Chem Corp. v. Commissioner, 88 T.C. 654, 662 (1987);

B.C. Cook & Sons, Inc. v. Commissioner, 65 T.C. 422, 428 (1975), aff’d per

curiam, 584 F.2d 53 (5th Cir. 1978); secs. 1.61-3(a), 1.162-1(a), 1.471-3, Income

Tax Regs. The taxpayer must substantiate the amount claimed as cost of goods

sold, and the taxpayer must maintain sufficient records for that purpose. Sec.

6001; sec. 1.6001-1(a), Income Tax Regs.; see Higbee v. Commissioner, 116 T.C.

438, 440 (2001); Rodriguez v. Commissioner, T.C. Memo. 2009-22; Said v.

Commissioner, T.C. Memo. 2003-148, aff’d, 112 Fed. Appx. 608 (9th Cir. 2004).

      Before we discuss petitioner and his spouse’s eligibility for the costs of

goods sold and the deductions claimed on the subject Schedules C for OMA

Enterprises, several general observations about their evidence are appropriate.

The first observation deals with the invoices that petitioner submitted to

substantiate the tax benefits claimed on the Schedules C. All of those invoices are

attached to the Stipulation of Facts in one of three exhibits to that stipulation.

Taken together, the invoices purport to show purchases during 2009 and 2010

aggregating approximately $212,161.78.

      Those invoices raise more questions than they answer. For example, the

invoices for 2009 show purchases totaling $135,785.12, whereas the aggregate

cost of goods sold and deductions claimed on the Schedule C for 2009 is $75,284,
                                           -10-

or $60,501.12 less than the total invoices for 2009. Similarly, the invoices for

2010 show purchases totaling $76,376.66 whereas the aggregate costs of goods

sold and deductions claimed on the Schedule C for 2010 is $56,956, or $19,420.66

less than the total invoices for 2010. In summary, petitioner submitted invoices

totaling $212,161.78 to substantiate deductions and costs of goods sold totaling

$132,240.

      We are at a loss to understand the nature of the excess invoices totaling

$79,921.78. Petitioner has not asked to be allowed deductions and/or costs of

goods sold in excess of the amounts claimed on the Schedules C. Furthermore,

each Schedule C states that it was prepared using the cash method of accounting.

We are unaware of any reason for a timing difference between the invoice year

and the time a particular expenditure is taken into account for tax purposes.

      A second observation about petitioner’s evidence is the fact that petitioner

introduced no books or records for OMA Enterprises, and there is nothing in the

record that ties a specific invoice or invoices to the amount claimed on a particular

line of either Schedule C. This problem was discussed at trial as follows:

      THE COURT: Do you have anything that shows the composition of
      each of the expenses that were claimed on your Schedule C?
      MR. ALUBUNKUDI: I didn’t understand what you say, sir.

      *          *          *          *          *         *          *
                                          -11-

       THE COURT: Well, on Schedule C you claimed an office expense in
       2009 of $3,161. Do you have anything that shows what were the
       amounts that you deducted as part of that $3,161?

Petitioner could not answer the Court’s concern, and the record provides no way to

tie the invoices petitioner produced to the cost of goods sold and business

deductions claimed on the Schedules C.

       Petitioner’s testimony at trial about the conduct of his business was vague

and confusing. Petitioner initially testified that he had purchased damaged cars

from a company called Copart, Inc.: “I buy used cars from a place called Copart,

cars that has an accident. When I buy them, I go to junkyard to buy the parts and

fix it in order to resell it.”

       Petitioner then testified that he had actually purchased the damaged cars

through another company, Sanchase Auto. Petitioner explained that Sanchase

Auto had a “license” to buy cars from Copart and Sanchase Auto allowed him to

use its license. Petitioner referred to two receipts issued by Sanchase Auto to

“Wally A Akanji.” One receipt, dated June 3, 2009, is for the purchase of 7 cars in

the aggregate amount of $33,135, and a second receipt, dated December 3, 2010,

is for the purchase 10 cars in the aggregate amount of $55,360.

       After that, petitioner testified: “When I bid for car, I went for the car, then I

go to Copart and pay with my money.” Thus, he seemed to contradict himself by
                                       -12-

stating that he paid Copart for the cars, not Sanchase Auto. According to

petitioner, he paid Copart with cashier’s checks obtained from Bank of America.

He explained: “That’s the only way you can pay to Copart.” If petitioner paid

Copart for the cars, we do not understand the purpose of the invoices from

Sanchase Auto.

      Petitioner explained that he kept copies of the cashier’s checks used to pay

Copart in a briefcase in his personal car but they were lost when the briefcase was

stolen from his automobile. According to petitioner, he used cash to purchase the

cashier’s checks from Bank of America. Petitioner did not explain why he chose

to pay for the cashier’s check with cash instead of simply causing the money for

the cashier’s checks to be withdrawn from his Bank of America account. In any

event, petitioner is now unable to show that he purchased any of the cashier’s

checks that he claims to have given to Copart. In passing, we note that the Court

had continued this case from a prior calendar for the express purpose of giving

petitioner additional time to obtain bank documents.

      We find curious another aspect of petitioner’s testimony about the business

of OMA Enterprises. The record contains invoices dated during 2009 for the

purchase of 11 cars through Copart by another company called Discount Motors,

Inc., in Washington, D.C. These 11 invoices total $90,689.98. Petitioner did not
                                        -13-

mention these invoices during his testimony or explain what connection, if any, he

had to Discount Motors, Inc. None of these invoices is in petitioner’s name and,

as with the Sanchase Auto invoices, there is nothing in the record to show that

petitioner paid the invoices or purchased any of the automobiles described in the

invoices.

Cost of Goods Sold

      As discussed above, respondent determined in the notice of deficiency that

the records submitted during petitioner and his spouse’s audit were “incomplete

and inadequate” and did not substantiate the costs of goods sold reported on the

Schedules C for OMA Enterprises. As a result, respondent recomputed the gross

profit for the business using industry averages and adjusted the costs of goods sold

in accordance with that computation. Petitioner and his spouse bear the burden of

showing that respondent’s adjustments to the costs of goods sold are wrong and

that they are entitled to claim more than the amounts respondent allowed . See

Rule 142.

      Petitioner’s description of the business of OMA Enterprises suggests that

the cost of goods sold for the business would consist of the cost of the damaged

automobiles and the parts used to repair them. As discussed above, the invoices

submitted are not sufficient to prove that petitioner purchased any such goods.
                                        -14-

Furthermore, petitioner’s testimony was vague and contradictory. On the basis of

the record in this case, we find that petitioner and his spouse have not

substantiated cost of goods sold for either year in excess of the amount respondent

allowed.

Office Expenses

      On the Schedules C for OMA Enterprises, petitioner and his spouse claimed

deductions for office expenses of $3,161 for 2009 and $4,813 for 2010. As

mentioned above, petitioner was unable to show the Court which of the invoices

correspond to the expenditures reported as office expenses. Nevertheless, using

the invoices and petitioner’s testimony, the Court has identified the following

invoices for purchases that appear to have been classified as office expenses:

           Date                     Description                            Amount

      June 1, 2009           Dell Inspiron 1545 Laptop                     $404.46

      June 7, 2009           Dell Vostro A860 Laptop                        548.91

       Total                                                                953.37

      May 27, 2010           Dell Photo A/O 926 Printer
                             Dell 2155 cdn Multifunction Printer            623.81

      May 27, 2010           Dell Laptop Inspiron 17 Laptop                1,603.93

      May 30, 2010           Dell Inspiron 1501 Laptop                      890.24
                                         -15-

      2010                   Oscar’s Carpet One                             48.15

       Total                                                             3,166.13

      The above invoices purport to show expenditures of $953.37 in 2009 and

$3,166.13 in 2010. According to these invoices, petitioner purchased two laptop

computers in 2009, two laptop computers in 2010, two printers in 2010, and

something from Oscar’s Carpet One in 2010. As to those expenditures,

petitioner’s testimony about what type of computers he purchased was confusing.

The invoices show that he purchased four laptops whereas petitioner testified that

he purchased two desktops and one laptop. We find the above invoices and

petitioner’s testimony to be insufficient to substantiate the deduction for office

expenses claimed for each of the subject years.

Depreciation

      On the Schedule C for OMA Enterprises for 2010, petitioner and his spouse

claimed a deduction for depreciation and section 179 expense of $4,595. Section

179 provides that a taxpayer may elect to treat the cost of any section 179 property

as an expense which is not chargeable to a capital account. If a taxpayer makes

this election, the cost shall be allowed as a deduction for the taxable year in which

the section 179 property is placed in service. Sec. 179(a). Section 179 property is

defined in pertinent part as “tangible property”, which is section 1245 property (as
                                         -16-

defined in section 1245(a)(3)) and which is acquired by purchase for use in the

active conduct of a trade or business. Sec. 179(d)(1).

      According to the Form 4562, Depreciation and Amortization (Including

Information on Listed Property), and the depreciation schedule filed with

petitioner and his spouse’s return, the subject deduction for the costs of a

“Computer”, purchased for $943 on February 1, 2010, and “Equipment”,

purchased for $3,652 on January 15, 2010. The record contains no further

description of these assets. At trial, petitioner stated that the items must be “spare

car parts”. Petitioner then concluded: “I’m not sure.” We find that petitioner and

his spouse have not met the burden of proving that respondent’s disallowance of

this deduction was wrong.

Car and Truck Expenses

      On the Schedules C for OMA Enterprises, petitioner and his spouse claimed

deductions for car and truck expenses of $7,314 for 2009 and $15,399 for 2010.

There is no other mention of these car and truck expenses in the record of this

case, except for the statement in the stipulation of facts that “[p]etitioners did not

provide documents, such as contemporaneous mileage log, in an attempt to

substantiate ‘Car and Truck’ expenses.” Because there is nothing in the record to

substantiate these expenses, we find that petitioner and his spouse have not
                                         -17-

established entitlement to the car and truck expense deduction claimed on the

subject returns.

Legal and Professional Services

      On the Schedules C for OMA Enterprises, petitioner and his spouse claimed

deductions for legal and professional services of $1,541 for 2009 and $3,633 for

2010. Petitioner conceded these deductions at trial.

Accuracy-Related Penalty Under Section 6662(a)

      Respondent determined in the notice of deficiency that the underpayments

of tax in this case are attributable to negligence or disregard of rules or

regulations, or to substantial understatements of income tax. Accordingly,

respondent added to the tax deficiencies accuracy-related penalties imposed by

section 6662(a).

      Under section 6662(a) and (b)(1) and (2) a taxpayer may be liable for a

penalty of 20% of the portion of an underpayment of tax due to negligence or

disregard of rules or regulations, or due to any substantial understatement of

income tax. The term “negligence” in section 6662(b)(1) includes any failure to

make a reasonable attempt to comply with the Internal Revenue Code; this may

include a failure to keep adequate books and records or to substantiate items

properly. Sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs. Negligence has
                                         -18-

also been defined as the failure to exercise due care or the failure to do what a

reasonable person would do under the circumstances. See Allen v. Commissioner,

92 T.C. 1, 12 (1989), aff’d, 925 F.2d 348 (9th Cir. 1991); Neely v. Commissioner,

85 T.C. 934, 947 (1985). The term “disregard” includes any careless, reckless, or

intentional disregard. Sec. 6662(c). In the case of an individual, the phrase

“substantial understatement of income tax” is defined as an understatement that

exceeds the greater of $5,000 or 10% of the tax required to be shown on the return.

Sec. 6662(d)(1)(A).

      Normally, the Commissioner bears the burden of production with respect to

the liability of an individual taxpayer for the accuracy-related penalty. Sec.

7491(c). To meet that burden, the Commissioner must produce sufficient evidence

indicating that it is appropriate to impose the penalty. See Higbee v.

Commissioner, 116 T.C. at 446. Once the Commissioner meets the burden of

production, the taxpayer must come forward with persuasive evidence that the

Commissioner’s determination is incorrect. Rule 142(a); see Higbee v.

Commissioner, 116 T.C. at 446-447. The taxpayer may meet this burden by

proving that he acted with reasonable cause and in good faith. See sec.

6664(c)(1); sec. 1.6664-4(a), Income Tax Regs.
                                          -19-

      Petitioner and his spouse failed to take issue in the petition with

respondent’s determination in the notice of deficiency imposing accuracy-related

penalties under section 6662(a). Furthermore, petitioner did not take issue with

the penalties at trial. He made no mention of them. In Funk v. Commissioner, 123

T.C. 213, 218 (2004), the Court stated:

      where a petition fails to state a claim in respect of penalties, additions
      to tax, and/or additional amounts, the Commissioner incurs no
      obligation to produce evidence in support of such determinations
      pursuant to section 7491(c). See, e.g., Parker v. Commissioner, 117
      F.3d 785, 787 (5th Cir. 1997) (the Commissioner has no obligation to
      investigate (or produce evidence with respect to) a third-party
      payment report that is not disputed by the taxpayer).

Respondent argues that he has no burden under section 7491(c) to produce

evidence that the section 6662(a) penalties are appropriate because petitioner and

his spouse are deemed to have conceded the penalties by failing to assign error to

them in the petition and by failing to raise an issue about them at trial. See id.;

Swain v. Commissioner, 118 T.C. 358, 363-364 (2002).

      We need not decide that issue because there is more than enough evidence

to show that accuracy-related penalties under section 6662(a) should be imposed

in this case. For example, as discussed above, petitioner and his spouse failed to

keep adequate books and records and failed to properly substantiate expenses

relating to the cost of goods sold and deductions claimed. Thus, it is clear, for
                                         -20-

purposes of section 6662(b)(1), that all of each underpayment is due to negligence,

and we so find. Furthermore, alternatively, even though the exact amounts of the

underpayments will depend upon Rule 155 computations, taking into account our

findings and conclusions herein, it appears to be the case that, for purposes of

section 6662(b)(2), there is a substantial understatement of income tax for both

2009 and 2010.

      Notwithstanding the above findings, no penalty will be imposed under

section 6662(a) with respect to any portion of an underpayment if it is shown that

there was reasonable cause for such portion and that the taxpayer acted in good

faith with respect to such portion. See sec. 6664(c). Whether a taxpayer acted in

good faith depends upon the facts and circumstances of each case. See sec.

1.6664-4(b)(1), Income Tax Regs.

      Petitioner did not explicitly argue reasonable cause and good faith.

Nevertheless, on occasion during his testimony, he mentioned the fact that he had

retained a return preparer to prepare the tax returns. Reliance on a professional

return preparer may constitute reasonable cause and good faith if the taxpayer

establishes: (1) the return preparer had sufficient expertise to justify reliance; (2)

the taxpayer provided necessary and accurate information to the return preparer;

and (3) the taxpayer actually relied in good faith on the return preparer’s
                                         -21-

judgment. E.g., Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99

(2000), aff’d, 299 F.3d 221 (3d Cir. 2002).

      Apart from passing references in petitioner’s testimony to the tax return

preparer, the record is devoid of any evidence to support a finding that any

reliance by petitioner and his spouse on a return preparer was reasonable and in

good faith. Petitioner did not call the tax return preparer as a witness. There is no

evidence as to the advice the tax return preparer might have given; no evidence to

support a determination that petitioner and his spouse acted reasonably or in good

faith in relying upon it; no evidence about the tax return preparer’s qualifications;

no evidence that all relevant facts and circumstances were disclosed to the tax

return preparer; and no evidence that the advice was based on reasonable factual

or legal assumptions. See id. More fundamentally, petitioner and his spouse have

not shown reasonable cause for the failure to keep adequate records to substantiate

expenses relating to the claimed deductions. Accordingly, we hold petitioner and

his spouse liable for section 6662(a) penalties for negligence and, alternatively, for

substantial understatements of income tax insofar as the Rule 155 computations

show any.
                                 -22-

On the basis of the above concessions by the parties,


                                        Decision will be entered under

                                Rule 155.
