                       T.C. Memo. 1998-244



                     UNITED STATES TAX COURT



          MICHAEL E. AND NANCY HENTGES, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent


     Docket No. 11049-96.                       Filed July 6, 1998.


     James A. Hogue and James O. Goodwin, for petitioners.

     William F. Castor, for respondent.



                       MEMORANDUM OPINION


     COUVILLION, Special Trial Judge:     This case was heard

pursuant to section 7443A(b)1 and Rules 180, 181, and 182.




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


     Respondent determined a deficiency of $8,116 in Federal

income tax and an accuracy-related penalty under section 6662(a)

in the amount of $1,623 for petitioners' 1992 tax year.

     After a concession by petitioners, the issues for decision

are whether petitioners properly substantiated certain trade or

business expenses under section 274(d), and whether petitioners

are liable for the penalty under section 6662(a) for a

substantial understatement of tax under section 6662(b)(2).2

     Some of the facts were stipulated.   Those facts, with the

annexed exhibits, are so found and are incorporated herein by

reference.   At the time the petition was filed, petitioners were

legal residents of Tulsa, Oklahoma.

     During the year in question, Michael E. Hentges (petitioner)

was primarily engaged in the sale of insurance and securities

and, to some extent, engaged in estate planning and financial

consultation.   He has been in such business since 1984.   Many of

his clients were located in various States.   Petitioner made

frequent business trips to contact and solicit new clients, and

virtually all of his travel was by private plane, which he

rented.   For local transportation, petitioner owned a 1983

Mercedes automobile that he used exclusively in his business.

     2
          At trial, petitioners conceded an adjustment in the
notice of deficiency for their failure to report as income on
their 1992 return an IRA distribution of $6,220. Petitioners
also conceded the 10-percent additional tax under sec. 72(t) for
the early distribution of the IRA.
                                - 3 -


     For the year 1992, a portion of petitioner's income from his

activities was paid to him as a salary.   That amount, $55,053,

was reflected by a Form W-2, and petitioners reported that amount

as salary and wage income on page 1 of their Federal income tax

return.   Another portion of petitioner's business was considered

as a self-employed trade or business activity, and, to reflect

that activity, petitioners reported their income and expenses on

a Schedule C of their return.   For 1992, petitioners reported

gross receipts from this activity of $13,889, expenses of

$35,878, and a net loss of $21,989.

     With respect to the self-employed activity, respondent, in

the notice of deficiency, allowed $10,350 of the claimed expenses

and disallowed $25,528 of the claimed expenses.   The disallowed

expenses have been classified into three groups and consist of

the following:


     (1) Expenses relating to a Mercedes automobile:3

          Car expenses                  $1,991
          Depreciation                   2,550
          Insurance                      2,362
          Repairs                        3,322              $10,225

     (2) Airplane rental, including rent,
         piloting, and fuel expenses                         9,826


     3
          With respect to the Mercedes automobile, petitioners
elected to claim deductions for the actual expenses incurred in
operating the vehicle in lieu of the standard mileage rate of 28
cents per mile allowable for 1992 under Rev. Proc. 92-104, 1992-2
C.B. 583.
                               - 4 -


     (3) Travel, meals, & entertainment:

         Travel                           2,460
         Meals & entertainment (80%)      3,017               5,477

            Total disallowed expenses                      $25,528


The stated reason for disallowance of these expenses is that the

expenses were not substantiated pursuant to section 274(d).

Petitioners challenge that determination.4

     With respect to the airplane, since petitioner was not a

licensed pilot during 1992, he was required to engage the

services of a licensed pilot on the trips he made in connection

with his business.   Petitioner, however, was also taking flying

lessons during 1992, and, on several of his business trips,

petitioner engaged his flight instructor as the pilot.    Each such

flight, however, qualified as a training lesson for petitioner.

The bill submitted by the pilot for each of these trips

identifies the charge as a fee for flight instruction.

Petitioner maintains, however, that such charges were no higher

than the costs of a regular pilot.     At the same time, petitioner

argues, each such trip contributed to his training for

     4
          Insofar as any of the $25,528 of expenses at issue may
be attributable to petitioner's activity as an employee rather
than as a self-employed individual, respondent conceded at trial
that petitioner qualified as an employee under sec. 3121(d)(3)(B)
as a full-time life insurance salesman; therefore, any expenses
allocable to petitioner's income as an employee would not be
subject to the 2-percent limitation of sec. 67(a). Thus, such
expenses would be treated in the same manner as petitioner's
self-employed activity expenses.
                                - 5 -


qualification for a pilot's license, which he subsequently

obtained.    The $9,826 shown above, therefore, includes the

pilot/instructor fees just described.    The Mercedes automobile,

referred to above, was used exclusively in petitioner's business

activity as petitioners owned another vehicle, a Jeep Cherokee,

which they used for personal purposes.

     With respect to the record keeping for all of the expenses

at issue, the only log petitioner maintained with respect to the

airplane was the log required by the Federal Aviation

Administration (the FAA).    Petitioner stored this log in his

flight bag along with receipts incurred in connection with

operation of the airplane.    Sometime during 1992, the flight bag

was stolen, and neither the bag nor its contents were ever

recovered.    Under FAA regulations, petitioner was required to

reconstruct his flight log, and the information from the

reconstructed log is what petitioner relies on here for

substantiation of the expenses claimed in connection with the

airplane.5   To reconstruct the expenses for operation of the

aircraft for the period prior to the theft, petitioner simply

averaged the expenses he thereafter incurred and claims those

     5
          The log itself was not introduced into evidence,
although petitioner submitted a "Reconstruction of Travel Expense
Log", which presumably contains the same information that the FAA
log contains. However, the document introduced into evidence
covers the entire year 1992, even though petitioner testified
that the FAA log was reconstructed only up to the date of the
loss of the original log.
                                - 6 -


averaged expenses as his substantiation for the portion of 1992

preceding the theft.

     As to the Mercedes automobile, petitioner did not maintain,

nor did he prepare for use at trial, a log chronicling his

business use of the automobile during 1992.    Petitioner maintains

that, since the car was used exclusively for business purposes, a

log was not necessary.6

     With respect to the meals and entertainment expenses,

petitioner did not maintain a contemporaneous log for such

expenses, although he offered into evidence at trial a stack of

receipts in substantiation of these expenses.    He also submitted

a three-page listing of the dates, location, "person seen",

matters "discussed", and the amounts for each event.    This

document is also entitled "Reconstruction of Meals Entertainment

Log".    Petitioner explained that the amounts shown were not a

complete listing because his practice was to keep receipts on his

person, and, every week or so, he would enter the transactions on


     6
          The Court notes that, in arguing that this vehicle was
used exclusively for business, petitioner did not address at
trial whether the car was also used for commuting to and from his
place of business, and whether petitioner considered such use as
business use. From the evidence adduced at trial, it is likely
that petitioner may have used the Mercedes for commuting because
petitioners had one other vehicle, and, since Mrs. Hentges was
gainfully employed during 1992, the probability appears to be
that she used the other vehicle for her commuting, and petitioner
used the Mercedes for his commuting. The use of a vehicle for
commuting to and from work is a personal use, and the expense
related thereto is rendered nondeductible by sec. 263.
                                 - 7 -


his computer.   Some of these receipts, he acknowledged, were lost

in the washing of his clothes.    He asserted he made no claim for

such lost receipts on his 1992 return.

     All taxpayers are required to keep records to enable the

Commissioner to determine their correct tax liability.    Sec.

6001; Meneguzzo v. Commissioner, 43 T.C. 824, 831-832 (1965).

Deductions are a matter of legislative grace, and the taxpayer

bears the burden of proof to establish entitlement to any claimed

deduction.   Rule 142(a); New Colonial Ice Co. v. Helvering, 292

U.S. 435, 440 (1934).    This includes substantiation of the

deductions claimed.     Hradesky v. Commissioner, 65 T.C. 87, 90

(1975), affd. per curiam 540 F.2d 821 (5th Cir. 1976).

     All of the expenses at issue here, to be deductible, must

meet the substantiation requirements of section 274(d).    The

parties do not dispute that.    Section 274(d) provides generally

that no deduction shall be allowed for any travel expense

incurred while away from home or for any item with respect to an

activity that is of a type generally considered to constitute

entertainment, amusement, or recreation, unless the taxpayer

substantiates 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, or recreation, (C) the business purpose

of the expense, and (D) the business relationship to the taxpayer
                                 - 8 -


of the persons entertained.    Under the regulations, to meet the

"adequate records" requirement of section 274(d), a taxpayer

"shall maintain an account book, diary, statement of expense or

similar record * * * and documentary evidence * * * which, in

combination, are sufficient to establish each element of an

expenditure".    Sec. 1.274-5(c)(2)(i), Income Tax Regs.; emphasis

added.    The elements to be proven with respect to each travel

expense are the amount, time, place, and business purpose of the

travel.    Sec. 1.274-5(b)(2), Income Tax Regs.   Similarly, the

elements to be proven with respect to entertainment expenses are

the amount, time, place, business purpose, and the business

relationship of the person or persons entertained.     Sec. 1.274-

5(b)(3), Income Tax Regs.    The record-keeping requirements of

section 274(d) contemplate that a record "made at or near the

time of the expenditure, supported by sufficient documentary

evidence, has a high degree of credibility not present with

respect to a statement prepared subsequent thereto when generally

there is a lack of accurate recall."     Sec. 1.274-5(c)(1), Income

Tax Regs.    The substantiation requirements of section 274(d) are

designed to encourage taxpayers to maintain records, together

with documentary evidence substantiating each element of the

expense sought to be deducted.    Sec. 1.274-5(c)(1), Income Tax

Regs.    Similarly, with respect to local transportation expenses,

section 274(d) was amended, effective for taxable years beginning
                               - 9 -


after December 31, 1985, to include the same substantiation

requirement for expenses claimed with respect to the use of

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

See sec. 274(d)(4).   "Listed property" includes, among others,

any passenger automobile or "any other property used as a means

of transportation".   Sec. 280F(d)(4)(A)(i) and (ii).   An

airplane, of course, is considered to be listed property.    Sec.

1.280F-6T(b)(2), Temporary Income Tax Regs., 49 Fed. Reg. 42701,

42713 (Oct. 24, 1984).

     The substantiation requirements of section 274(d) with

respect to expenses for travel away from home, meals,

entertainment, and expenses relating to the use of listed

property effectively preclude this Court from the use or

application of the "Cohan rule", Cohan v. Commissioner, 39 F.2d

540, 543-544 (2d Cir. 1930), in allowing deductions for expenses

where the Court is satisfied from the record that expenses have

been incurred but the taxpayer has not adequately substantiated

the amount of such expenses.   Unless the stringent substantiation

requirements are met for those categories of expenses covered by

section 274(d), this Court has no choice but to disallow such

expenses.

     Petitioners correctly argue that, because petitioner's

records as to the airplane were stolen, which was a circumstance

beyond his control, there are relief provisions in the
                               - 10 -


regulations that allow a taxpayer to reconstruct his records,

citing section 1.274-5T(c)(4) and (5), Temporary Income Tax

Regs., 50 Fed. Reg. 46006, 46021-46022 (Nov. 6, 1985).    The Court

notes, however, that petitioner's records were lost, through

theft, for only a portion of the year at issue, and only the

airplane FAA log and some of the receipts relating to the

airplane were so lost.   Petitioner suffered no such loss of

records with respect to the other expenses at issue, nor were

such records lost as to the airplane for the remainder of 1992.

The Court, therefore, considers whether the records petitioner

submitted that were not lost and, therefore, were not

reconstructed pass muster under section 274(d).    The records

submitted do not satisfy the record-keeping requirements of

section 274(d) for several reasons.     Most notably, petitioner did

not maintain a contemporaneous record of the expenses, at or near

the time they were incurred.   Perhaps the most important element

of the record-keeping requirement is the contemporaneous

maintenance of a log, chronicling each event in which an expense

is incurred and corroborating that expense with receipts or other

documents evidencing that the expense was incurred.    The

documentation submitted by petitioner fails to satisfy this

requisite.   Although petitioner submitted numerous cash and

credit card receipts, most of these receipts bear no information

tying the receipt to an event or an expense.    The reconstructed
                             - 11 -


logs provide very little information to satisfy what section

274(d) and the regulations require.    With respect to the

airplane, virtually all of the receipts for payment of the pilot

are specified to be for flight instructions rather than for pilot

services.

     Petitioners did not contend that expenses for petitioner's

flight training were deductible expenses but contended that such

expenses were incurred during a trade or business activity.

However, the logs petitioners submitted into evidence and some of

the receipts contradict petitioners' claim that expenses for the

flight instructor were claimed only in connection with flights

involving petitioner's business.    For example, included in

petitioner's documentation is a receipt dated December 15, 1992,

in the amount of $300, from petitioner's flight instructor.    The

travel log submitted into evidence does not reflect any business

travel involving use of the airplane on December 15, 1992.

Moreover, the Meals Entertainment Log offered into evidence shows

that petitioner had a meal on December 15, 1992, at "Chili's"

restaurant with a Rusty Hargrove.    While the location of this

restaurant is not indicated, it appears to the Court that this

restaurant was probably a local restaurant.    Petitioner's

presence in Tulsa, Oklahoma, that day contradicts his claim that

he was on business travel that day in the airplane.    There are

several other similar instances of contradictions in petitioner's
                               - 12 -


records in addition to the foregoing example.   That particular

example, the Court notes, did not involve records that were lost.

     The Court concludes, on this record, that, for the period

during 1992 as to which petitioner's records were not stolen,

such records fail to satisfy the substantiation requirements of

section 274(d).   In addition, there is no evidence that his

record keeping was more complete or adequate for the period

before the theft.    In A & F Management Corp. v. Commissioner,

T.C. Memo. 1984-585, this Court stated:


     This exception to the general substantiation requirements is
     available where the taxpayer once had adequate records which
     were destroyed by a casualty beyond the taxpayer's control,
     and the exception permits the taxpayer to substantiate a
     deduction by reasonable reconstruction of his expenditures.
     * * * None of the documents submitted into evidence met all
     of the elements of section 274(d) nor did * * * [the
     taxpayer's] testimony indicate that any of the materials
     that were destroyed contained this information.
     Consequently, we will not permit petitioners to attempt to
     reconstruct A & F's records without satisfying each element
     of section 274(d). * * *


In Bacon v. Commissioner, T.C. Memo. 1989-90, this Court found

that a taxpayer failed to make an adequate reconstruction of

destroyed records where such records did not initially contain

sufficient information to satisfy the substantiation requirements

of section 274(d).    Counsel for petitioner at trial agreed that

the log maintained by petitioner required by the FAA would not

have included all the information necessary to satisfy the

requirements of section 274(d).   Petitioner admittedly did not
                                - 13 -


maintain any other log on the use of the airplane.      We find that

petitioner's reconstruction of the destroyed records is not

reasonable or adequate in the circumstances to come within the

lost records exception of the regulations.    With respect to the

Mercedes automobile, the Court rejects petitioner's contention

that a log was not necessary for that vehicle because it was used

exclusively in his business.    As noted earlier, a

contemporaneously prepared log for that vehicle would have

disproved any personal use of the vehicle and, most importantly,

would have established the business purposes for which the car

was being used.   The Court, therefore, sustains respondent on all

of the expenses at issue.

     Respondent determined that petitioners were liable for the

penalty under section 6662(a) for a substantial understatement of

tax under section 6662(b)(2).    Section 6662(a) provides that, if

it is applicable to any portion of an underpayment in taxes,

there shall be added to the tax an amount equal to 20 percent of

the portion of the underpayment to which section 6662 applies.

There is a substantial understatement of tax if the amount of the

understatement exceeds the greater of (1) 10 percent of the tax

required to be shown on the return, or (2) $5,000.      Sec.

6662(d)(1)(A).    For purposes of section 6662(d)(1),

"understatement" is defined as the excess of tax required to be
                              - 14 -


shown on the return over the amount of tax that is shown on the

return, reduced by any rebates.   Sec. 6662(d)(2)(A).

     Section 6662(d)(2)(B) provides that the amount of the

understatement shall be reduced by that portion of the

understatement that is attributable to the tax treatment of any

item by the taxpayer if there is or was substantial authority for

the treatment, or any item with respect to which the relevant

facts affecting the item's tax treatment are adequately disclosed

in the return or in a statement attached to the return, and there

is reasonable basis for such treatment.

     Petitioners did not establish that any of the exonerating

provisions of section 6662 or section 6664(c) would apply to

reduce the amount of, or extinguish the existence of, a

substantial understatement of income tax for 1992.    Moreover,

petitioners conceded the underpayment of tax attributable to

their failure to report the IRA distribution on their 1992

return.   Respondent, therefore, is sustained on the section

6662(a) penalty.



                                          Decision will be entered

                                    for respondent.
