                               T.C. Memo. 2014-199



                         UNITED STATES TAX COURT



           BINH NGUYEN AND NHAT K. NGUYEN, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 26033-12.                        Filed September 30, 2014.



      Jan R. Pierce, for petitioner.

      Nhi T. Luu, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      GERBER, Judge:1 Respondent determined income tax deficiencies of

$5,587 and $2,039 for petitioners’ 2009 and 2010 tax years, respectively.


      1
       The trial in this case, on June 9, 2014, was before Judge Diane Kroupa and
with the agreement of the parties the case was reassigned to Senior Judge Joel
Gerber for the purpose of rendering an opinion.
                                        -2-

[*2] Respondent also determined accuracy-related penalties of $1,117.40 and

$407.80 under section 6662(a)2 for 2009 and 2010, respectively. After

concessions,3 the issues remaining for us to consider are: (1) whether petitioners

are entitled to an amount for cost of goods sold in excess of the amount respondent

allowed for 2009, (2) whether petitioners are entitled to deduct an amount for

supplies in excess of the amount respondent allowed for 2010, and (3) whether

petitioners are liable for the section 6662(a) accuracy-related penalty for 2009

and/or 2010.

                              FINDINGS OF FACT4

      Petitioners resided in Oregon when their petition was filed. Petitioners were

married during 2009 and 2010 and filed joint Federal income tax returns.

Petitioners each operated a sole proprietorship, and Schedules C, Profit or Loss

From Business, were attached to their returns for each business. The cost of goods



      2
      Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect for the years at issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
      3
       Petitioners concede that they are not entitled to the portions of the
depreciation deductions attributable to land that they claimed on Schedules E,
Supplemental Income and Loss, for the years in issue.
      4
       The parties’ Stipulation of Facts and the exhibits are incorporated by this
reference.
                                        -3-

[*3] sold and deductions in question relate to Mr. Nguyen’s hardwood floor

installation business.

      Mr. Nguyen moved to the United States in 1992 after completion of the

ninth grade in Vietnam, and he began his business in 1997. Mr. Nguyen has

limited proficiency in English, but he is able to negotiate the terms of flooring jobs

with his customers. While he cannot read English, Mr. Nguyen does enter into

brief written contracts with his customers.

      Mr. Nguyen did not maintain an inventory of flooring materials during the

years at issue. He generally purchased the flooring that would be installed for

each job, but in some instances he would install flooring purchased by the

customer. In addition to flooring, Mr. Nguyen purchased supplies in connection

with his business, such as wood, paper, glue, and nails. He purchased these

supplies using debit card, checks, and cash.

      Mr. Nguyen kept his 2009 business bank statements in the drawer of the

desk in his family room. He kept receipts for the 2009 business expenses in a bag

in a hallway in the basement. Sometime in September or October 2009 the water

heater in petitioners’ home caused a flood, and some of the business receipts were

destroyed.
                                        -4-

[*4] John E. Wynn of Payroll Professionals LTC prepared petitioners’ 2009

return. Petitioners provided Mr. Wynn with the 2009 bank statements and

surviving receipts so that he could prepare the return. Mr. Wynn prepared

petitioners’ 2009 return during a single meeting that lasted approximately one

hour. The cost of goods sold claimed on Mr. Nguyen’s 2009 Schedule C was

$43,503. During the initial examination, respondent determined that petitioners

substantiated $17,981 of the amount claimed. After review of additional

documents petitioners provided, including bank statements, receipts, and invoices,

respondent determined that petitioners had substantiated an additional $114.66 for

cost of goods sold.

      Mr. Wynn also reported $5,675 for supplies on Mr. Nguyen’s 2009

Schedule C. Mr. Wynn did not explain to petitioners the difference between items

reported as cost of goods sold and those reported as supplies. Although Mr.

Nguyen was unsure of what made up the deduction for supplies, respondent

allowed the amount claimed.

      Mr. Wynn did not return all of petitioners’ documents after the preparation

of their return. Petitioners subpoenaed Mr. Wynn to appear at trial,5 but he did not


      5
       Petitioners’ son sent the subpoena to Payroll Professionals LTC via
facsimile and slid a copy under the office’s door.
                                         -5-

[*5] appear; and there is nothing in the record establishing his credentials or

experience.

      At the end of 2009 petitioners moved into a new home where Mr. Nguyen

continued to keep his 2010 bank statements in his desk drawer. He also kept the

2010 business expense receipts in a bag.

      Petitioners’ 2010 return was prepared by Henrietta Browning of Tax

Solutions Center, LLC, using the information on the 2009 return as a guide. No

other documents or records were provided to Ms. Browning. The Schedule C for

Mr. Nguyen’s business for 2010 claimed a $39,894 deduction for supplies.

During the initial examination, respondent determined that petitioners

substantiated $24,490 of the amount claimed. After review of additional

documents petitioners provided, including bank statements, receipts, and invoices,

respondent determined that petitioners had substantiated $178.26 more. Ms.

Browning was not called to testify at the trial.

                                      OPINION

      Respondent allowed only portions of the deductions claimed on petitioners’

returns. We must decide whether petitioners have shown entitlement to

deductions in excess of those respondent allowed. We must also decide whether

petitioners are liable for the accuracy-related penalty.
                                        -6-

[*6]   Deductions are a matter of legislative grace, and taxpayers bear the burden

of establishing entitlement to any claimed deduction. Rule 142(a); INDOPCO,

Inc. v. Commissioner, 503 U.S. 79, 84 (1992). Taxpayers are required to maintain

records sufficient to allow the Commissioner to determine their correct tax

liability. Sec. 6001; sec. 1.6001-1(a), Income Tax Regs. Additionally, taxpayers

bear the burden of substantiating the amount and purpose of each item for which

they claim a deduction. Hradesky v. Commissioner, 65 T.C. 87, 89 (1975), aff’d

per curiam, 540 F.2d 821 (5th Cir. 1976).6

       Petitioners claimed a $43,503 reduction from gross income for the cost of

goods sold on Mr. Nguyen’s Schedule C attached to the 2009 return. Petitioners

experienced a flood in 2009 in the basement of their home where the receipts for

Mr. Nguyen’s business were stored. While the flood destroyed some of the

business’ receipts, Mr. Nguyen testified that the 2009 return was prepared using

bank statements and the receipts that were not destroyed.

       On the basis of his initial examination, respondent determined that $17,981

of the cost of goods sold had been substantiated. Petitioners provided bank

statements, receipts, and invoices to respondent, and, upon further review,

       6
        No question was raised by either party regarding shifting of the burden of
proof or going forward with the evidence. Thus, the burden of proof remains on
petitioners. See sec. 7491(a).
                                        -7-

[*7] respondent determined that an additional $114.66 of the cost of goods sold

had been substantiated. The only documentary evidence petitioners offered into

the record for 2009 was incomplete bank statements. Further, Mr. Nguyen failed

to provide any testimony regarding specific expenditures related to flooring jobs

for which deductions should be allowed but were denied by respondent.

      Petitioners have not offered evidence that would allow us to decide that they

are entitled to cost of goods sold in excess of the amount respondent determined

was substantiated. Accordingly, we hold that petitioners are not entitled to claim

cost of goods sold for 2009 in excess of the amount determined or agreed to by

respondent.

      Petitioners reported $39,894 for supplies on the 2010 return. Mr. Nguyen

testified that the 2010 return was prepared using only the 2009 return as a guide.

The only evidence offered for 2010 was bank statements. Again, Mr. Nguyen did

not provide any testimony regarding expenses for supplies related to flooring jobs

that were paid but for which respondent disallowed deductions. Nor did he

provide any testimony indicating that he paid expenses related to supplies in

excess of the amount respondent has determined is allowable as a deduction.

Accordingly, we hold that petitioners are entitled to a deduction for supplies equal

to the amount respondent determined was substantiated for 2010.
                                        -8-

[*8] Section 6662(a) and (b)(1) and (2) imposes an accuracy-related penalty of

20% on the portion of an underpayment attributable to negligence or a substantial

understatement of income tax. Negligence includes any failure to keep adequate

books and records or to substantiate items properly. Sec. 1.6662-3(b)(1), Income

Tax Regs.

      With respect to the accuracy-related penalty, the Commissioner bears the

burden of production. Sec. 7491(c). This requires the Commissioner to “come

forward with sufficient evidence indicating that it is appropriate to impose” the

accuracy-related penalty. Higbee v. Commissioner, 116 T.C. 438, 446 (2001).

Once the Commissioner provides sufficient information to satisfy his burden of

production, the burden shifts to the taxpayer to show that the penalty should not be

applied. Id. at 447; see Rule 142. Petitioners have failed to provide adequate

records to substantiate fully the amounts claimed for cost of goods sold in 20097

      7
       Petitioners experienced a flood in their home in 2009; however, Mr.
Nguyen testified that the 2009 return was prepared using his complete bank
statements and receipts that survived the flood. He also testified that he purchased
supplies for his business using cash, checks, and debit card. Those expenses paid
using a debit card or checks would be reflected on the bank statements.
Withdrawals of cash from Mr. Nguyen’s business bank account used to purchase
materials and supplies would be reflected on the statements. The only expenses
that would not have a connection to the 2009 bank statements would be cash
expenditures for supplies not derived from the business or received from
customers but not deposited in the business account. Consequently, the flood
                                                                        (continued...)
                                        -9-

[*9] and supplies in 2010. By showing that petitioners lack adequate records to

substantiate fully the amounts claimed, respondent has met his burden of

production. See sec. 1.6662-3(b)(1), Income Tax Regs.

      Section 6664(c)(1) provides an exception to the section 6662 penalty if the

taxpayer can establish that there was reasonable cause for the underpayment and

that the taxpayer acted in good faith. Sec. 1.6664-4(a), Income Tax Regs.

Whether a taxpayer acted with reasonable cause and in good faith is determined in

each case by taking into account all relevant facts and circumstances. Reliance on

the advice of a professional tax adviser does not necessarily demonstrate

reasonable cause and good faith, but it can in certain situations. Freytag v.

Commissioner, 89 T.C. 849, 888 (1987), aff’d, 904 F.2d 1011 (5th Cir. 1990),

aff’d, 501 U.S. 868 (1991); sec. 1.6664-4(b)(1), Income Tax Regs. In determining

whether a taxpayer reasonably relied in good faith on the advice of a professional

tax adviser, the taxpayer’s education, sophistication, and business experience will

be taken into consideration. Sec. 1.6664-4(c)(1), Income Tax Regs. Further, in

order for reliance on a professional tax adviser to excuse the taxpayer from the

section 6662 penalty, the taxpayer must prove: (1) the adviser was a competent

      7
       (...continued)
cannot serve as a reason petitioners are unable to provide substantiation for all of
the amounts claimed as cost of goods sold for 2009.
                                        - 10 -

[*10] professional with sufficient expertise to justify reliance; (2) the taxpayer

provided the adviser necessary and accurate information; and (3) the taxpayer

actually relied in good faith on the adviser’s judgment. See Neonatology Assocs.,

P.A. v. Commissioner, 115 T.C. 43, 98-99 (2000), aff’d, 299 F.3d 221 (3d Cir.

2002).

      Mr. Nguyen came to the United States in 1992 after completion of the ninth

grade in Vietnam. Although his English skills are limited, Mr. Nguyen has

successfully operated his business since 1997. He provided Mr. Wynn complete

bank statements and receipts that survived the flood to prepare petitioners’ 2009

return. Mr. Nguyen relied on Mr. Wynn’s judgment to determine which amounts

were deductible for his business and testified that he trusted Mr. Wynn.

Nevertheless, Mr. Wynn did not appear at trial, and no evidence was introduced to

establish Mr. Wynn’s credibility or experience preparing Federal income tax

returns. Consequently, petitioners have not shown that they acted in good faith

and that there was reasonable cause for the underpayment. We hold that

petitioners are liable for a section 6662(a) penalty for 2009.

      At trial petitioners presented no evidence to show they acted in good faith

and that the underpayment for 2010 was due to reasonable cause. We accordingly
                                        - 11 -

[*11] hold that petitioners are also liable for the section 6662(a) accuracy-related

penalty for 2010.

      To reflect concessions of the parties and the additional amounts respondent

determined were substantiated after the notice of deficiency was issued,


                                                 Decision will be entered under

                                       Rule 155.
