                             T.C. Memo. 2018-132



                        UNITED STATES TAX COURT



             RAGHVENDRA SINGH AND KIRAN RAWAT,
                          Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 6093-16.                         Filed August 22, 2018.



      Raghvendra Singh and Kiran Rawat, pro sese.

      Tyson R. Smith, Sharyn M. Ortega, and Brian A. Pfeifer, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      VASQUEZ, Judge: Respondent determined a deficiency in petitioners’

Federal income tax of $35,821 and a section 6662(a) accuracy-related penalty of
                                         -2-

[*2] $7,164.20 for taxable year 2012.1 The issues for decision are whether

petitioners are: (1) entitled to cost of goods sold (COGS) and various deductions

claimed on a Schedule C, Profit or Loss From Business; (2) entitled to deductions

for home mortgage interest and property taxes claimed on a Schedule A, Itemized

Deductions; (3) entitled to a deduction for purported losses they did not claim on

their return; and (4) liable for a section 6662(a) accuracy-related penalty.

                               FINDINGS OF FACT

      Some of the facts have been stipulated and are so found. We incorporate

paragraphs 1, 3, 4, and 6 of the stipulation of facts and accompanying Exhibits 1-J

and 3-P by this reference. Petitioners resided in California when they filed their

petition.

      Petitioners timely filed a joint Form 1040, U.S. Individual Income Tax

Return, for 2012. The return included a Schedule C for a “Repair and Sales”

business. On the Schedule C petitioners reported COGS of $100,604 and

deductible expenses of $37,912. Petitioners reported these expenses as follows:




      1
         All section references are to the Internal Revenue Code in effect for the
year in issue, and all Rule references are to the Tax Court Rules of Practice and
Procedure.
                                        -3-

[*3]                 Expense                                Amount

            Travel                                           $3,624
            Taxes and licenses                                  556
            Supplies                                            734
            Other business property                             456
            Commissions and fees                                416
            Advertising                                         502
            Utilities                                         3,462
            Meals and entertainment                             184
            Repairs and maintenance                           4,632
            Office expense                                    3,136
            Insurance                                         1,632
            Car and truck                                     4,420
            Legal and professional
             services                                        13,624
            Rent for vehicles,
             machinery, and equipment                           534
             Total                                           37,912

       Petitioners’ return also included a Schedule A, on which petitioners claimed

a deduction of $31,009 for home mortgage interest and a deduction of $29,321 for

real estate taxes.

       Respondent issued a notice of deficiency to petitioners for their taxable year

2012 disallowing all of petitioners’ Schedule C deductions and COGS.

Respondent also disallowed petitioners’ Schedule A deductions for home

mortgage interest and real estate taxes. Additionally, respondent determined that

petitioners are liable for the accuracy-related penalty under section 6662(a).
                                        -4-

[*4] Petitioners timely petitioned this Court. In their petition they alleged that

respondent “refused to consider other losses.”

                                     OPINION

I.    Burden of Proof

      As a general rule, the Commissioner’s determinations of a taxpayer’s

liability in a notice of deficiency are presumed correct, and the taxpayer bears the

burden of proving that those determinations are erroneous. Rule 142(a); Welch v.

Helvering, 290 U.S. 111, 115 (1933). Deductions are a matter of legislative grace,

and the taxpayer generally bears the burden of proving entitlement to any

deduction claimed.2 Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79,

84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).

      When the taxpayer establishes that he has paid or incurred deductible

expenses but is unable to substantiate the exact amounts, we can estimate the

deductible amount in some circumstances, but only if the taxpayer presents


      2
          Sec. 7491(a) provides that if, in any Court proceeding, a taxpayer
introduces credible evidence with respect to any factual issue relevant to
ascertaining the liability of the taxpayer for any tax imposed by subtit. A or B and
meets other prerequisites, the Secretary shall have the burden of proof with respect
to that issue. Higbee v. Commissioner, 116 T.C. 438, 440-441 (2001). However,
petitioners have neither claimed nor shown that they satisfied the requirements of
sec. 7491(a) to shift the burden of proof to respondent. Accordingly, petitioners
bear the burden of proof. See Rule 142(a).
                                        -5-

[*5] sufficient evidence to establish a rational basis for making the estimate

(Cohan rule). See Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930);

Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985). In estimating the amount

allowable, we bear heavily upon the taxpayer whose inexactitude is of his own

making. See Cohan v. Commissioner, 39 F.2d at 544. There must be sufficient

evidence in the record to permit us to conclude that a deductible expense was paid

or incurred. Williams v. United States, 245 F.2d 559, 560 (5th Cir. 1957).

      For certain kinds of business expenses, section 274(d) overrides the Cohan

rule. See Sanford v. Commissioner, 50 T.C. 823, 827-828 (1968), aff’d per

curiam, 412 F.2d 201 (2d Cir. 1969). Section 274(d) provides that no deduction is

allowed with respect to travel, entertainment, or listed property (as defined in

section 280F(d)(4)) unless the taxpayer substantiates by adequate records or by

sufficient evidence corroborating the taxpayer’s own statement (1) the amount of

expense or item; (2) the time and place of the travel, entertainment, or expense;

(3) the business purpose of the entertainment or expense; and (4) the business

relationship to the taxpayer of the person or persons entertained.
                                         -6-

[*6] II.     Petitioners’ Schedule C

       A.    Expenses

       Section 162(a) permits a taxpayer to deduct ordinary and necessary

expenses paid or incurred in carrying on a trade or business. See Commissioner v.

Lincoln Sav. & Loan Ass’n, 403 U.S. 345, 352 (1971). A trade or business

expense is ordinary if it is normal or customary within a particular trade, business,

or industry, and it is necessary if it is appropriate and helpful for the development

of the business. Commissioner v. Heininger, 320 U.S. 467, 471 (1943); Welch v.

Helvering, 290 U.S. at 113-114.

       On their Schedule C petitioners claimed deductions of $37,912 for various

expenses. However, petitioners did not offer any receipts or other reliable

evidence to show that their claimed expenses were actually paid in 2012. Instead

they offered vague and uncorroborated testimony, along with a 2012 statement of

expense allegedly prepared by their accountant Kate Szasz.

       The statement lists purported payments for machinery, cars, trucks,

attorney’s fees, and “compensation”. We are unable to rely on this document. Ms.

Szasz, who prepared the statement, was not present at trial. While we believe

petitioner husband’s testimony that Ms. Szasz is deceased, it is unclear from the

record how she calculated petitioners’ purported expenses. Furthermore, the
                                        -7-

[*7] attorney’s fees listed on the expense statement do not match the amount of the

deduction on the Schedule C. With respect to the car and truck expenses, the

statement does not specify the business purpose of the vehicles and therefore fails

to satisfy the requirements of section 274.3

      On the basis of the record before us, petitioners have not established that

they paid or incurred their reported Schedule C expenses in 2012. Accordingly,

we sustain respondent’s determination to disallow petitioners’ Schedule C

deductions.

      B.      COGS

      On their Schedule C petitioners reported COGS of $100,604, which

respondent disallowed in full.

      COGS is subtracted from gross receipts to compute gross business income.

Sec. 1.61-3(a), Income Tax Regs. It is not a deduction and is not subject to the

limits on deductions in section 162, Metra Chem. Corp. v. Commissioner, 88 T.C.

654, 661 (1987), but any amount reported as COGS still has to be substantiated,

      3
          Petitioner husband testified that his business records were destroyed in a
fire. It is well established that the Court may permit a taxpayer to attempt to
substantiate deductions through secondary evidence where the underlying
documents have been unintentionally lost or destroyed. Boyd v. Commissioner,
122 T.C. 305, 320-321 (2004); Furnish v. Commissioner, T.C. Memo. 2001-286,
slip. op. at 11. However, in this case, petitioners’ evidence consists of unreliable
documents and equivocal testimony.
                                           -8-

[*8] King v. Commissioner, T.C. Memo. 1994-318, 1994 WL 330613, at *2, aff’d

without published opinion, 69 F.3d 544 (9th Cir. 1995). Because petitioners have

not presented any reliable evidence to establish that they had any COGS, we

sustain respondent’s disallowance.

III.   Petitioner’s Schedule A

       We next address the issues of petitioners’ Schedule A deductions for home

mortgage interest and real estate taxes.

       A.    Home Mortgage Interest

       Petitioners claimed a deduction of $31,009 for home mortgage interest.

Respondent argues that petitioners have not substantiated their home mortgage

interest expense.

       Generally, a taxpayer may claim a deduction for “all interest paid or accrued

within the taxable year on indebtedness.” Sec. 163(a). Indebtedness has been

held to mean an unconditional and legally enforceable obligation for payment of

money. Linder v. Commissioner, 68 T.C. 792, 796 (1977). However, a taxpayer

generally is not allowed a deduction for personal interest paid or accrued during

the taxable year. Sec. 163(h). There is an exception to this rule under section

163(h)(2)(D) which allows a deduction for qualified residence interest. A
                                          -9-

[*9] qualified residence is the taxpayer’s personal residence and one other

residence of the taxpayer. Sec. 163(h)(4)(A).

      Petitioner husband testified that the mortgage interest deduction pertained to

their Elk Grove, California, residence, which they purportedly purchased in 2009

for $350,000.4 However, he was unable to recall the amount of his monthly

mortgage payment in 2012. Petitioners also failed to proffer any Forms 1098,

Mortgage Interest Statement, reflecting home mortgage interest paid to creditors.

      The Cohan rule allows us to estimate the amount of certain deductible

expenses, but only when there is sufficient evidence in the record to support such

an estimate. See Cohan v. Commissioner, 39 F.2d at 543-544. In the present case

there is little evidence that petitioners paid or even had a mortgage in 2012. Even

if they did, the record does not establish how much of any yearly mortgage

payment is allocable to interest. Accordingly, because we cannot ascertain with

any certainty the existence or amount of any home mortgage interest payments, we

sustain respondent’s determination.

      B.      Real Estate Taxes

      Respondent also disallowed petitioners’ deduction of $29,321 for real estate

taxes. Section 164(a)(1) allows taxpayers to deduct “State and local, and foreign,

      4
          Petitioners listed a post office box as their address on their 2012 return.
                                         - 10 -

[*10] real property taxes.” At trial petitioner husband testified that petitioners

paid real estate taxes on various properties. However, petitioners did not identify

the properties or offer documents corroborating petitioner husband’s vague

testimony. Because petitioners have not presented reliable evidence supporting

their deduction for real estate taxes, we sustain respondent’s determination.

IV.   Other Losses

      At trial and on brief petitioners argued that they are entitled to deduct

certain losses for 2012 that they did not claim on their return (other losses).

Petitioners presented no reliable evidence that establishes their entitlement to these

other losses. On the basis of our examination of the entire record before us, we

find that petitioners have failed to carry their burden of establishing that for the

year in issue they are entitled to deduct certain other losses.

V.    Section 6662(a) Accuracy-Related Penalty

      Finally we consider whether petitioners are liable for an accuracy-related

penalty under section 6662(a).

      Pursuant to section 6662(a) and (b)(1), a taxpayer may be liable for a

penalty of 20% on the portion of an underpayment of tax attributable to negligence

or disregard of rules or regulations. However, a taxpayer is not liable for the

accuracy-related penalty if there was reasonable cause for that portion of the
                                       - 11 -

[*11] underpayment and the taxpayer acted in good faith. Sec. 6664(c)(1); sec.

1.6664-4(a), Income Tax Regs.

      The Commissioner has the burden of production with respect to the

accuracy-related penalty. Sec. 7491(c). To meet this burden, the Commissioner

must produce sufficient evidence indicating that it is appropriate to impose the

penalty. See Higbee v. Commissioner, 116 T.C. 438, 446 (2001). The

Commissioner’s burden of production under section 7491(c) includes establishing

compliance with the written supervisory approval requirement of section 6751(b).5

Graev v. Commissioner, 149 T.C. ___, ___ (slip op. at 14) (Dec. 20, 2017),

supplementing and overruling in part 147 T.C. 460 (2016); see also Chai v.

Commissioner, 851 F.3d 190, 222 (2d Cir. 2017) (citing Higbee v. Commissioner,

116 T.C. at 446), aff’g in part, rev’g in part T.C. Memo. 2015-42. If the

Commissioner satisfies his burden, the taxpayer then bears the ultimate burden of

persuasion. Higbee v. Commissioner, 116 T.C. at 446-447. The taxpayer may

meet his burden by proving that he acted with reasonable cause and in good faith

with respect to the underpayment. See sec. 6664(c)(1); see also Higbee v.

Commissioner, 116 T.C. at 447; sec. 1.6664-4(b)(1), Income Tax Regs.


      5
        Sec. 6751(b) requires written supervisory approval of the initial
determination of certain penalties.
                                       - 12 -

[*12] Respondent did not introduce evidence of written supervisory approval of

the initial determination of the penalty before us. Accordingly, respondent did not

meet his burden of production, and we do not sustain his imposition of the section

6662(a) accuracy-related penalty. See secs. 6751(b), 7491(c); Graev v.

Commissioner, 149 T.C. at      (slip op. at 14-15).

      In reaching all of our holdings herein, we have considered all arguments

made by the parties, and to the extent not mentioned above, we conclude they are

irrelevant, moot, or without merit.

      To reflect the foregoing,


                                                Decision will be entered for

                                       respondent as to the deficiency and for

                                       petitioners as to the accuracy-related penalty

                                       under section 6662(a).
