                             T.C. Memo. 2012-38


                       UNITED STATES TAX COURT



    STEVEN A. ESRIG, Petitioner v. COMMISSIONER OF INTERNAL
                      REVENUE, Respondent

STEVEN A. ESRIG AND LORI S. ESRIG, Petitioners v. COMMISSIONER OF
                INTERNAL REVENUE, Respondent



    Docket Nos. 18797-03, 16806-08.              Filed February 7, 2012.



    Steven A. Esrig and Lori S. Esrig, pro se.

    Bradley C. Plovan, for respondent.
                                         -2-

            MEMORANDUM FINDINGS OF FACT AND OPINION


       HOLMES, Judge: Steven and Lori Esrig didn’t timely file their tax returns

for any year from 1998 through 2003. For some years they were so late that the

Commissioner prepared substitute returns for them, 1 and for all those years he sent

them notices of deficiency. But the Esrigs claim the Commissioner got it all wrong,

that they don’t owe any taxes, additions to tax, or penalties because they were

involved in a number of businesses for which, in total, they have more losses and

deductions than income. The case is all about substantiation, and we therefore must

decide whether the Esrigs have substantiated their claimed losses and deductions,

and then figure out how much they owe in taxes, additions to tax, and penalties, if

any.




       1
         When the Commissioner learns that someone has received income--usually
from third parties under a duty to report--but has not filed a return, section 6020(b)
gives him the power to prepare a “substitute for return” (SFR). An SFR is not a
comprehensive return; the Commissioner uses only one of the two filing statuses--
single or married filing separately--and he allows only one personal exemption and
no business expenses or personal deductions. See Internal Revenue Manual pt.
4.19.17.1.3.1 (Nov. 10, 2006). (Unless we say otherwise, all section references are
to the Internal Revenue Code in effect for the years in issue. All Rule references are
to the Tax Court Rules of Practice and Procedure.)
                                          -3-

                                FINDINGS OF FACT

      Steven and Lori Esrig earned much of their income from real-estate sales and

investments in securities. Lori was licensed as a real-estate broker,2 and had her

own business buying and selling real estate for others. Steven was an entrepreneur.

      Sometime before 1998, the Esrigs decided to go into business together,

starting SEC Financial Services, Inc.--a company Steven said rented, renovated, and

repaired properties owned by the Esrigs, and even some owned by others. Steven

explained that Lori bought, sold, and rented out the real estate, but he himself

handled the day-to-day maintenance and repair work. He also claimed that SEC

produced income from the rent they received and the repair work SEC’s crew

performed for other property owners.

      Steven testified that SEC had one full-time employee who helped out, and

from time to time he would also “hire either college students or other part-time

renovation tradesmen, electricians, carpenters, plumbers, [and] that type of thing.”

He claimed that SEC didn’t actually pay the student workers, but that they did



      2
        A licensed real-estate broker has to complete more coursework than a
licensed real-estate agent. In most states, a real-estate agent must be supervised by
a broker. Selling real estate independently often requires a broker’s license.
                                           -4-

cleanup work in exchange for a discount on their rent. SEC did pay its

subcontractors, however, and Steven said that he kept records of how much he paid

and to whom. He also said that he and his wife kept calendar records of the time

they spent doing work for SEC. But even though he said all this, he actually

introduced no supporting documents or other proof of SEC’s expenses.

      By early 2002 the Esrigs were out of the real-estate rental and repair business

and had sold off all their rental properties. Lori still had her real-estate sales

business, but Steven started a new company called Stelor Productions, Inc. (He

chose the name “Stelor” because it was a portmanteau of Steven and Lori.)

      Steven told us at trial that he got the idea for the company after an incident

involving one of his children. Apparently, his then-five-year-old child asked to look

at the Power Rangers website. Steven logged on but inadvertently mistyped a

character in the web address. Instead of getting the Power Rangers website, up

popped a seriously pornographic one. This, he told us, was the reason he started

Stelor, a company he claims invented a technology that protects children from

predators and pornography and “shuts down identity theft.” We find, however, that

much of Steven’s trial testimony was not credible, and this particular tale we believe

to be nothing more than a pourquoi story.
                                         -5-

      What we do find is that Stelor operated out of the Esrigs’ home in

Darnestown, Maryland, and even paid some rent: $3,600 in 2002, and $68,400 in

2003. Steven was the president and CEO of the company; and Stelor did have a

board of directors and several other investors.

      Stelor, however, never made any money and lost most (if not all) of what the

investors put in. Steven told us that the company failed because it “ran into some

litigation” after it bought the domain name “googles.com” from someone who had it

before Google. This, he said, led to five or six years of litigation with Google and

ultimately bankrupted his company.3


      3
        Some background from the public record: Sometime before August 1997,
Steven A. Silvers, a convicted narcotics trafficker and money launderer, wrote a
children’s book about loveable four-eyed alien creatures called “Googles” who live
on the planet Goo. See United States v. Silvers, 90 F.3d 95 (4th Cir. 1996); United
States v. Silvers, 932 F. Supp. 702 (D. Md. 1996); Stelor Prods., Inc., v. Google,
Inc., No. 05-80387, 2008 U.S. Dist. LEXIS 74936, at *3 (S.D. Fla. Sept. 15, 2008)
(order partially granting plaintiff’s motion to compel and defendant’s motion for
protective order). Silvers said he wanted to use his Googles to teach children about
social values. Stelor Prods., Inc., v. Google, Inc., No. 05-80387, 2008 U.S. Dist.
LEXIS 74936, at *3 (S.D. Fla. Sept. 15, 2008) (order partially granting plaintiff’s
motion to compel and defendant’s motion for protective order). In 1997 Silvers
registered the domain name googles.com (coincidentally around the time Google,
Inc. registered its IP address) claiming that he wanted to develop an interactive
children’s website to promote and sell books and other Googles merchandise. Id.

     In 2002, Stelor acquired Silvers’s rights to sell Googles products and use the
Googles trademarks, intellectual property, and IP address. Stelor Prods., LLC, v.
                                                                       (continued...)
                                          -6-

                                      OPINION

      The Commissioner noticed that the Esrigs hadn’t filed their tax returns for

1998, 1999, and 2000, and sent Steven notices of deficiency for those three years in

August 2003. The notices asserted that Steven had more than $1.5 million in total

unreported taxable income and that he was also liable for various penalties.

      The Esrigs finally filed their 1998 and 1999 returns in late October 2003, and

their 2000 tax return a week later. Steven quickly filed his petition for all three

years. We set the case for trial in 2005, but the parties then agreed to continue the

case to see if they could settle after the Commissioner looked at the late-filed

returns.

      What happened instead was that the Commissioner got more curious about

the Esrigs, and expanded his investigation to later years and related companies. In

early 2008, he sent both Esrigs notices of deficiency for 2001, 2002, and 2003.

The Esrigs filed another petition for these years, which we consolidated with



      3
        (...continued)
Silvers, No. 05-80393 (S.D. Fla. July 17, 2006) (report and recommendations). It
then used them to sue other companies (one of which was Google) for trademark
infringement and the like. Stelor Prods., LLC v. Oogles N Googles Franchising,
LLC, No. 05-0354 (S.D. Ind. Jan. 13, 2009) (order of dismissal with prejudice of all
claims, counterclaims, and third party claims); Stelor Prods., Inc. v. Google, Inc.,
No. 05-80387, 2008 U.S. Dist. LEXIS 74936, at *2 (S.D. Fla. Sept. 15, 2008).
                                           -7-

Steven’s earlier one. Settlement talks continued, but in the summer of 2009 the

Esrigs’ attorney moved to withdraw as counsel: The couple had filed for divorce,

and Steven wouldn’t waive the resulting conflict of interest.

       The case finally staggered to trial in Baltimore in 2010, with the Esrigs

representing themselves. They are, and were when they filed their petitions,

Maryland residents. After making several concessions, the Commissioner says

these are the deficiencies, additions to tax, and penalties still at issue:4




       4
        The Commissioner conceded enough deductions elsewhere in the notices of
deficiency and in the prolonged pretrial proceedings that it’s possible that the Esrigs
did not underpay for some of the years at issue. For any such years, of course, there
may not be penalties.
                                           -8-

                                          Additions to Tax/Penalties


Year Deficiency         Sec. 6651(a)(1)           Sec. 6654            Sec. 6662


1998       $124,983      $31,243.00               $5,672.01               ---
1999       261,455        65,260.25               12,534.00               ---
2000       203,841        50,965.50               10,962.43               ---
2001        22,407         4,617.25                  ---                $4,481
2002        40,387        10,066.75                  ---                 8,077
2003        52,918        19,834.25                  ---                10,584

And these are the particular items being disputed:

       !      net operating loss (NOL) carryovers claimed for 1998-2003;

       !      SEC’s business losses for 1998-2002;

       !      office expenses deducted for 2002 and 2003;

       !      section 179 deduction for 2003;

       !      unreported rental income for 2002 and 2003;

       !      capital gain and losses for 2001 and 2002;

       !      additions to tax under section 6651(a)(1) for 1998-2003;

       !      additions to tax under section 6654 for failing to make estimated tax
              payments in 1998-2000; and

       !      accuracy-related penalties under section 6662 for 2001-2003.

Everything else is computational.
                                          -9-

I.    Substantiation Issues

      We begin by noting that the Esrigs bear the burden of proving the

Commissioner’s deficiency determinations are incorrect. See Rule 142(a);

INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992). The Code also requires

the Esrigs to maintain sufficient records to substantiate their claimed deductions.

See sec. 1.6001-1(a), Income Tax Regs. The fact that the Esrigs reported

deductions on their returns is not itself substantiation. See, e.g., Wilkinson v.

Commissioner, 71 T.C. 633, 639 (1979).
                                         -10-

      A.     NOL Carryovers

                           Total NOL                         Amount
      Year             carryovers claimed                allowed by IRS


      1998              $39,384 (1994)                         -0-
                         15,800 (1995)
                         45,989 (1996)
                        145,148 (1997)
                        246,321
      1999               39,384 (1994)                         -0-
                         15,800 (1995)
                         45,989 (1996)
                        145,148 (1997)
                        113,892 (1998)
                        360,213
      2000               73,316 (1997)                         -0-
                        113,892 (1998)
                        187,208
      2001               11,295 (1997)                         -0-
                        113,892 (1998)
                        125,187
      2002               26,649 (1998)                         -0-
                         26,649
      2003               26,649 (1998)                         -0-
                         13,777 (2002)
                         40,426

      In general, a taxpayer has an NOL when he has more deductions than

income in a given tax year. See sec. 172(c) and (d). Taxpayers with a big NOL in

one year may be able to report zero income in that year and use the remaining loss

to offset income in other years. See sec. 172(a) and (b). Section 172 says that an

NOL has to be carried back to the 2 taxable years before the loss year and,
                                        -11-

if the loss hasn’t been fully absorbed, forward up to 20 years.5 See sec. 172(b)(1).

The taxpayer, however, may elect to waive the carryback years. See sec.

172(b)(3).

      The parties dispute the NOL carryovers the Esrigs reported on their 1998-

2003 returns and that we summarize in the table above. To substantiate their NOL

carryovers, the Esrigs had to establish that they incurred NOLs for 1994, 1995,

1996, 1997, 1998, and 2002, and that they were entitled to carry those losses

forward to the years at issue.6 But the only documents they introduced to support

their NOLs are the returns they filed for 1998 through 2003, including certain IRS

worksheets used to help taxpayers with their NOL computations. Tax returns,

however, are not substantiation, see, e.g., Lawinger v. Commissioner, 103 T.C.

428, 438 (1994), so we sustain the Commissioner’s determination and disallow the

Esrigs’ NOLs.




      5
        Before the Taxpayer Relief Act of 1997, Pub. L. No. 105-34, sec. 1082(a),
111 Stat. at 950, an NOL was first carried back 3 tax years and then carried forward
for 15.
      6
         We may determine the amount of a net operating loss for a year--even if an
assessment of tax for that year is barred--to determine the correct NOL carryover
for the tax year that is at issue. See sec. 6214(b); Calumet Indus., Inc. v.
Commissioner, 95 T.C. 257, 274 (1990).
                                         -12-

      B.     Schedule E Losses: SEC Financial Services

                                    SEC Financial Services

                    Year        Per return            Per IRS

                    1998        ($79,399)                -0-
                    1999          (54,664)               -0-
                    2000          (42,842)               -0-
                    2001           (9,529)               -0-
                    2002          (22,014)               -0-
                    2003            4,065                -0-

      The Commissioner conceded the losses the Esrigs reported on their Schedule

E for their “Real Estate Rental Business” and for “EGG, International” but

continues to dispute the losses the Esrigs reported for SEC on their 1998-2002

returns. The Commissioner argues that the Esrigs haven’t shown that SEC was

engaged in a trade or business, and that they haven’t shown that SEC actually

incurred the expenses that generated the losses claimed on their returns.

      The Commissioner has a point: The only evidence of SEC’s business

activities--other than the Esrigs’ tax returns--that we could find in the record was a

Maryland building contractor’s license issued in 2003, and of course Steven’s own

testimony. The documentary evidence isn’t enough to prove the SEC losses,
                                       -13-

and Steven’s testimony didn’t jibe with what was reported on the Esrigs’ returns.

We do not find it credible.

      The Esrigs reported income, expenses, and losses from their real-estate

rental properties separately, and the Commissioner generously left those items

unadjusted. SEC, however, didn’t report any gross receipts for 1998 through

2002.7 We therefore aren’t sure why the Esrigs claimed additional losses and

expenses for SEC on their returns, and what they were for.

      We also can’t apply the rule of Cohan v. Commissioner, 39 F.2d 540 (2d

Cir. 1930), and estimate the proper deductions because we have no reasonable way

to approximate SEC’s deductible business expenses from the record. See

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

Commissioner, 85 T.C. 731, 742-43 (1985). We find for the Commissioner on this

issue, and don’t even need to address his argument that SEC was not a trade or

business.




      7
        In 2003 SEC reported $4,650 of net income, but we have no idea how it
was earned and where it came from. The Commissioner has agreed that this income
doesn’t exist, and reduced the Esrig’s 2003 tax liability by a corresponding amount.
                                            -14-

        C.      Office Expenses

 Year            Per Return             Per IRS             Office Expense at Issue


              Steven     Lori      Steven          Lori   Steven       Lori       Total


 2002        $11,248   $11,885    $2,885      $3,522      $8,363    $8,363      $16,726


 2003         70,361     1,928    47,890       1,928      22,471        ---      22,471


        The Esrigs both worked out of their 13,000-square-foot home and deducted

office expenses during all the years in dispute. The Commissioner, however,

challenges many of their office-expense deductions only for 2002 and 2003. He

says that the Esrigs haven’t shown that they had office expenses in an amount

greater than what he’s already allowed them for 2002; he also argues that the

Esrigs shouldn’t have taken an office-expense deduction on their 2003 return for

the costs of painting the exterior of their home and maintaining a fish tank. We

agree: The Esrigs offered no credible evidence on these points.

        D.      Section 179 Expense

        Steven claimed a $17,700 deduction under section 1798 on his 2003 tax

return for the cost of a fish tank and dining room furniture. The Commissioner

        8
        Sec. 179 allows a taxpayer in some circumstances to deduct the entire cost
of a capital asset in the year it’s first used in a business, rather than depreciating that
cost over the asset’s life.
                                          -15-

disallowed these expenses because the Esrigs weren’t able to demonstrate the

business use of the property.

      The only evidence they offered at trial to substantiate this deduction was

Steven’s testimony. He told us that both he and his wife used their dining room

table primarily for business meetings, and that they put in a fish tank in the foyer of

their home where their business contacts would sit and wait for meetings. We did

not find Steven’s testimony credible, and agree with the Commissioner on this issue

as well.

      E.     Unreported Rental Income

                 Year           Claimed    Amount determined by IRS


                  2002            0                   $3,600
                  2003            0                   68,400

      Steven admitted at trial that the Esrigs received rent from Stelor for the

business use of their home. And on the returns signed by Steven on behalf of

Stelor, the company deducted rental expenses of $3,600 and $68,400 for 2002 and

2003. The Esrigs, however, didn’t report this income on their personal returns for

those two years. We therefore sustain the Commissioner’s determinations as to the

Esrigs’ unreported rental income for 2002 and 2003.
                                        -16-

      F.     Capital Gains

                                                                     Adjustment
     Year              Property sold           Gain/loss reported     to income


     1999      3254 Q Street                         $9,175              ---
     2000      3538 S Street                        159,282              ---
     2001      3407 R Street NW                     199,741            $47,306
     2002      2121 Marymount Drive                (130,599)           130,599
       Total                                                           177,905

      Someone who sells property is taxed on the gain, not the sale price. See

secs. 1001(a), 1011. The seller gets “basis” for the amount he paid for the

property, and his basis is then adjusted according to the rules in section 1016. See

secs. 1012, 1016. The gain is basically the amount the seller receives reduced by

the seller’s adjusted basis in the property. See sec. 1011.

      The Commissioner argues that the Esrigs had more gain on the sale of their

properties in 2001 and 2002 than what they reported because they overstated their

bases in both the R Street and Marymount Drive properties. The Esrigs presented

no evidence on this issue, so we find for the Commissioner once again.
                                          -17-

II.     Additions to Tax and Penalties

        The final issues are the additions to tax that the Commissioner asserts under

sections 6651(a)(1) and 6654, and the penalties under section 6662 for 2001-2003.

        A.     Section 6651(a)(1): 1998-2003

        Section 6651(a)(1) imposes an addition to tax for failing to timely file a tax

return. A taxpayer can beat the penalty by showing reasonable cause, id., which

here would mean proof that the Esrigs acted with ordinary business care and

prudence and nevertheless were still unable to file as required, see United States

v. Boyle, 469 U.S. 241, 246 (1985); sec. 301.6651-1(c)(1), Proced. & Admin.

Regs.

        The Esrigs were often very late in filing:

        Year             Filing date                 Tardiness of the return


        1998            Oct. 30, 2003                4 yrs. 6 mos. 15 days
        1999            Oct. 30, 2003                3 yrs. 6 mos. 13 days
        2000            Nov. 5, 2003                 2 yrs. 6 mos. 20 days
        2001           June 11, 2004                  2 yrs. 1 mo. 27 days
        2002            Oct. 12, 2004                 1 yr. 5 mos. 27 days
        2003           Dec. 27, 2005                  1 yr. 8 mos. 12 days
                                         -18-

       At trial Steven blamed the couple’s return preparer. He said that he’d asked

his accountant to request extensions for all the years at issue, but his accountant

missed all the deadlines because she had to serve a very long prison sentence for

murdering her husband, and the person in her office who took over their account

made a slew of mistakes.

       We aren’t convinced. The Esrigs had no evidence to corroborate this lurid

tale, and we therefore find that they had no reasonable cause for failing to timely

file. Accordingly, we find Steven liable for the failure-to-timely-file additions to

tax for 1998-2000 and both Esrigs liable for the failure-to-timely-file additions for

the later years.

       B.     Section 6654: 1998-2000

       The Commissioner also asserts additions to tax against Steven under section

6654 for the failure to pay estimated taxes for 1998-2000. We are satisfied that the

Commissioner has carried his burden in showing that Steven owed taxes and had

paid insufficient estimated taxes for those three years. The only tax payments the

Esrigs showed on any of the returns were a measly $11 in withholding for 1998 and

$416 for 2000, plus an earned income tax credit for 1998. We therefore find
                                          -19-

Steven liable for the section 6654 addition to tax for 1998, 1999, and 2000 if, of

course, the Rule 155 computations show an underpayment for those years.

      C.     Section 6662: 2001-2003

      The final issue is whether the Esrigs are liable for the 20% accuracy-related

penalty under section 6662(a) and (b)(1) and (2) for neglecting or disregarding the

tax rules and regulations, or for substantially understating their income tax liability.

      “Negligence” includes any failure to make a reasonable attempt to comply

with the provisions of the Code, including any failure to keep adequate books and

records or to substantiate items properly. See sec. 6662(c); sec. 1.6662-3(b)(1),

Income Tax Regs. And a “substantial understatement” includes an understatement

of income tax that exceeds the greater of 10% of the tax required to be shown on

the return or $5,000. See sec. 6662(d)(1)(A); sec. 1.6662-4(b), Income Tax Regs.

      The Commissioner certainly showed that the Esrigs kept generally

inadequate books and records for 2001-2003. Given that the Esrigs have not

produced any credible evidence to establish why this penalty should not apply for

2001-2003, we sustain the Commissioner’s determinations that they are liable for

the accuracy-related penalty on the ground of negligence for the entire amount of
                                         -20-

the underpayment for each of these years. We also specifically find that the Esrigs

were negligent in deducting from their 2003 income the cost of dining room

furniture and of feeding and housing their pet fish. We also specifically find them

negligent in failing to report the rental income they got from Stelor.


                                                      Decisions will be entered

                                                under Rule 155.
