                               T.C. Memo. 2019-38



                        UNITED STATES TAX COURT



     ESTATE OF SCOTT C. RONNING, DECEASED, HARLAN L. PAUL,
             PERSONAL REPRESENTATIVE, Petitioner v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 22469-11.                        Filed April 15, 2019.



      Frank G. Podesta, for petitioner.

      Lawrence D. Sledz, David Delduco, Christopher D. Bradely, and Courtney

S. Bacon, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      MORRISON, Judge: Scott C. Ronning, and his then-wife, Valerie Ronning,

filed joint income-tax returns for 2005, 2006, 2007, and 2008. In May 2009, Scott

Ronning filed for bankruptcy. In 2010, the Ronnings divorced. In May 2011, the
                                         -2-

[*2] bankruptcy case was closed without discharge. On June 30, 2011, the

respondent (or the “IRS”) issued notices of deficiency to the Ronnings. The

respondent determined the following income-tax deficiencies and accuracy-related

penalties under section 6662(a).1

                                                        Penalty
                     Year           Deficiency        sec. 6662(a)

                     2005             $23,635             -0-
                     2006             279,303             -0-
                     2007           1,988,382           $397,676
                     2008              83,858             16,358

Scott Ronning timely filed a Tax Court petition under section 6213(a) for a

redetermination of the deficiencies and penalties. We have jurisdiction under

section 6214(a).2 Scott Ronning died after he filed the Tax Court petition. The

personal representative of his estate, Harlan Paul, was substituted as the petitioner.




      1
       Unless otherwise indicated, all references to sections are to the Internal
Revenue Code of 1986, as amended, and all references to Rules are to the Tax
Court Rules of Practice and Procedure. All dollar amounts are rounded to the
nearest dollar.
      2
        Valerie Ronning did not petition the Court. Therefore, we do not have
jurisdiction to redetermine the deficiencies and penalties with respect to her. See
Rule 34(a); United States v. Jenkins, 780 F.2d 518 (5th Cir. 1986); Davenport v.
Commissioner, 48 T.C. 921 (1967).
                                        -3-

[*3] Our holdings are as follows:

      1. Cost of goods sold for Atlanta Site Consultants, LLC, for 2007.

Attached to the return for 2007 was a Schedule C, “Profit or Loss From Business”,

for Atlanta Site Consultants, LLC. The Schedule C reported cost of goods sold of

$7,175,870. The notice of deficiency determined that cost of goods sold was zero.

Before trial, the IRS conceded that cost of goods sold was $4,117,386. We hold

that cost of goods sold is $4,117,386. Furthermore, there should be no adjustment

to the $1,117,489 reported on the Schedule C for business-expense deductions.

      2. Net operating loss (NOL). As a computational result of our resolution of

the cost-of-goods-sold issue for 2007, there is (a) no NOL for 2007, (b) no NOL-

carryback deduction for 2005 and 2006 related to the carryback of an NOL for

2007, and (c) no NOL-carryforward deduction for 2008 for the carryforward of an

NOL for 2007.

      3. Gross income for 2008. The 2008 return failed to report $323,566 of

gross income.

      4. Section 6662(a) penalties for 2007 and 2008. There is a penalty under

section 6662(a) equal to 20% of the underpayment for 2007. There is no liability

for the penalty under section 6662(a) for 2008.
                                         -4-

[*4]                           FINDINGS OF FACT

Background

       Scott Ronning was a real-estate developer during the years at issue. He

operated his business through Atlanta Site Consultants, LLC. He was the sole

owner of this LLC, which was a disregarded entity for federal tax purposes.

       He also operated his real-estate business through one or more other LLCs

that were treated as partnerships for federal tax purposes.3

       Valerie Ronning worked as a real-estate agent during the years at issue.




       3
        On the Schedule E, “Supplemental Income and Loss”, of the Ronnings’
2007 return, the following entities are named as partnerships in which one of the
Ronnings had an interest: Southern Wallboard, LLC; Vintage Home Georgia,
LLC; and ABG Holdings I, LLC.
       When Scott Ronning declared bankruptcy in May 2009, he stated that he
had an ownership interest in the following entities: Atlanta Road Development,
LLC; Oaks at Powers Ferry Townhomes, LP; Daves Creek, LLC; Deep Water
Holdings, LLC; Sawgrass Landing, LLC; ABG Development, LLC; ABG
Holdings I, LLC; Atlanta Site Consultants, LLC; Clairmont Townhomes Atlanta,
LLC; Kelly Mill, LLC; Post Pittman, LLC; ABG SCR, LLC; Estates of Oakwood,
LLC; Townhomes of Briarwood, LLC; ABG Atlanta, LLC; Atlanta Partners, LLC;
Avenues Investment Group, LLC; Regency Atlanta, LLC; The Avenues
Development Group, LLC; Alpharetta Medical Partners, LLC, and Capital
Partners, LLC. The record is not sufficient to allow us to find that any of these
entities was an LLC, treated as a partnership for federal tax purposes, through
which Scott Ronning operated his real-estate business.
                                        -5-

[*5] Returns

      The Ronnings’ 2007 return, which was filed in 2008, was prepared by Perry

P. Gambrell, a certified public accountant (CPA). Gambrell prepared the return

based on a document he called a “trial balance”. He had received the trial balance

from the bookkeeping department that kept track of the finances of Scott

Ronning’s real-estate business. The bookkeeping department was under severe

strain when the 2007 return was filed. The department could not give Gambrell

more complete information about Scott Ronning’s real-estate business.

      The 2007 Schedule C for Atlanta Site Consultants, LLC, reported gross

receipts of $6,347,406. It reported that cost of goods sold was $7,175,870, which

it calculated as follows:

                      Inventory at beginning of year      -0-
                  +   Purchase costs                      -0-
                  +   Cost of labor                     $857,148
                  +   Materials and supplies           1,395,526
                  +   Other costs                      4,923,196
                  !   Inventory at end of year            -0-
                  =    Cost of goods sold              7,175,870

The Schedule C reported a net loss of $1,945,953, calculated as follows:

                 Gross receipts                            $6,347,406
               ! Cost of goods sold                         7,175,870
               ! Total business-expense deductions          1,117,489
               = Net loss                                   1,945,953
                                        -6-

[*6] The business-expense deductions were broken down into 17 categories.

      The Ronnings’ Schedule E for 2007 reported that the Ronnings had income

and losses from the following purported partnerships:

      !     Atlanta Site Consultants, LLC. $12,761 income.
      !     Southern Wallboard, LLC. $46,794 loss.
      !     Vintage Home Georgia, LLC. $10,903 loss.
      !     ABG Holdings I, LLC. $0.
      !     ABG Holdings I, LLC (“rental”). $0.

The total reported Schedule E loss is $44,936, which is the sum of the above

amounts. The record does not show how these amounts were derived. A partner

usually copies his or her amounts of partnership income and loss from Schedules

K-1, “Partner’s Share of Income, Deductions, Credits, etc.” There are no

Schedules K-1 in the record. There are no Forms 1065, “U.S. Return of

Partnership Income”, in the record either.

      The record does not show why the income and loss for Atlanta Site

Consultants, LLC, was reported on both Schedule C and Schedule E of the 2007

return. As we have found, Atlanta Site Consultants, LLC, was a disregarded

entity. The income and expenses of a disregarded entity are usually reflected on a

Schedule C rather than a Schedule E. The record does not show why there are two

entries on Schedule E for ABG Holdings I, LLC.
                                         -7-

[*7] In part because of the $1,945,953 net loss reported on the 2007 Schedule C

for Atlanta Site Consultants, LLC, the Ronnings reported an NOL for 2007. When

they filed their 2007 return, they simultaneously filed amended 2005 and 2006

returns to report carryback deductions for portions of the NOL from 2007.4

      When they filed their 2008 return, the Ronnings reported the carryforward

deduction for a portion of the NOL from 2007.

      To the 2008 return the Ronnings attached a Schedule C for Valerie

Ronning’s real-estate business. On Valerie Ronning’s Schedule C, they reported

the following amounts:

                     Gross receipts                       $68,255
                 !   Business-expense deductions          187,749
                 '    Net loss                            119,494

Bankruptcy petition; loss of records; marital separation; illness; and divorce

      In May 2009, Scott Ronning filed for personal bankruptcy. Among the

alleged debts listed in the bankruptcy petition are 22 debts from which the

petitioner would derive his litigation position in the Tax Court. The petitioner

      4
         The amended 2005 and 2006 returns differed from the original 2005 and
2006 returns only in that the amended returns reflected deductions for the
carrybacks of the NOL from 2007. It is unnecessary to describe either the original
2005 and 2006 returns or the amended 2005 and 2006 returns. That is because the
notice of deficiency made no adjustments for the 2005 and 2006 years except that
it disallowed the NOL-carryback deductions reported on the amended 2005 and
2006 returns.
                                           -8-

[*8] infers from the information in the bankruptcy petition about these 22 debts

that Scott Ronning incurred expenses and that these expenses should give rise to

cost-of-goods-sold allowances (or business-expense deductions) for 2007. The

amounts of the alleged expenses are calculated in Exhibit 14-P. We describe

Exhibit 14-P throughout our opinion.

       As related to the petitioner’s litigating position, the relevant information

about the 22 debts in the bankruptcy petition includes the name of the creditor, the

amount of the debt, the description of the debt, and any notation about there being

a codebtor. The table below contains this information from the bankruptcy

petition and the amount of expense calculated in Exhibit 14-P:

                                                                            Amt. of
                                                                            expense
                             Information           Co-       Amt. of       calculated
  Name of creditor            about debt          debtor      debt        in Ex. 14-P

 Georgia Dept. of       “2007 State Income          No
  Revenue                Tax”                                $55,000        $55,000

 IRS                    “2005 Federal               No
                         Employee Taxes”                       44,000        44,000

 IRS                    “2006 Federal               No
                         Withholding Taxes”                    21,000        21,000

 Bryan Cave             “Legal Services”            No         75,000        75,000
                                        -9-

[*9]                                                                  Amt. of
                                                                      expense
                          Information           Co-      Amt. of     calculated
  Name of creditor         about debt          debtor     debt      in Ex. 14-P

Davis, Pickren &     “Legal Services”           No       270,000     270,000
 Seydel LLP

Jon Oden, Esq.       “3/4/09 Legal              No
                      Services”                              441         441

Stites &             “Legal Services”           No        30,000      30,000
 Harbison

Weissman,            “3/3/09 Legal              No
 Nowack               services (ABG
                      Development LLC)”                    2,829       2,829

U.S. Fire            “Settlement                No
 Insurance            agreement (judgment
 Co.                  in lawsuit)”                       230,323     230,323

Liberty Mutual       “Personal Guarantee        No
                      (bond claim,
                      financial assistance)”             630,000     630,000

Alpharetta           “Personal Guarantee--      No
 Community            Atlanta Road
 Bank                 Development, LLC”                 5,014,272   1,001,582

Bank of North        “2/3/00 Personal           Yes
 Georgia              Guarantee--ABG
                      Holdings, I, LLC
                      and Vintage Homes
                      Georgia, LLC”                     4,150,000    307,868
                                    -10-

[*10]                                                                Amt. of
                                                                     expense
                         Information          Co-       Amt. of     calculated
  Name of creditor        about debt         debtor      debt      in Ex. 14-P

Builders             “Personal Guarantee--    Yes
 Firstsource-         Vintage Homes
 Atlantic             Georgia, LLC”                     350,000      25,965

Cecil B.             “Personal Guarantee--    Yes
 Foundation, Inc.     Daves Creek, LLC”                 750,000      62,337

Colonial Bank,       “Personal Guarantee--    Yes
 NA                   Atlanta Road
                      Development, LLC”                4,855,832    484,966

First Colony         “Personal Guarantee--    Yes
 Financial Corp.      Sawgrass Landing,
                      LLC”                             2,500,000     19,325

Integrity Bank       “Personal Guarantee--    Yes
                      Oaks at Powers
                      Ferry Townhomes,
                      LP”                             14,885,000   1,234,696

Integrity Bank       “Personal Guarantee--    Yes
                      Atlanta Road
                      Development, LLC”                    5,960        595

RBC Bank             “Personal Guarantee--    Yes
                      Daves Creek, LLC”                7,163,960    595,443

Royal Bank of        “Personal Guarantee--    Yes
Scotland PLC          Deep Water
                      Holdings, LLC”                  15,000,000    852,737
                                          -11-

[*11]                                                                        Amt. of
                                                                             expense
                              Information           Co-       Amt. of       calculated
  Name of creditor             about debt          debtor      debt        in Ex. 14-P

 The Zeist               “Personal Guarantee--      Yes
  Foundation, Inc.        Atlanta Road
                          Development, LLC”                 2,200,000        219,721

 Westplan Investors “Personal Guarantee--           Yes
                     Powers Ferry
                     Townhomes, LLC”                        3,500,000        290,908

        The information in the table above reflects the information reported by Scott

Ronning in his bankruptcy petition. The information does not constitute our

findings of fact.

        For the first 10 of the 22 debts listed in the table above, the cost-of-goods-

sold allowance (or business-expense deduction) the petitioner seeks exactly equals

the amount of the debt listed in the bankruptcy petition. For the last 12 debts, the

petitioner argues that interest accrued on the debt before the filing of the

bankruptcy petition and that there should be cost-of-goods-sold allowances (or

business-expense deductions) for tax year 2007 for the interest accruals. The

calculations of interest accruals are in Exhibit 14-P. More will be said of these

interest calculations infra part 1(b).
                                        -12-

[*12] At some point, all of Scott Ronning’s business records were moved into a

storage facility.

      In 2009, the storage facility notified Scott Ronning that it would destroy his

records because of nonpayment of storage fees.

      In 2009, the storage facility destroyed Scott Ronning’s records.

      Sometime in 2009, Scott and Valerie Ronning separated. It is unclear

whether they were separated before or after Scott Ronning filed the bankruptcy

petition in May 2009.

      In 2010, Scott Ronning became ill and was hospitalized.

      In 2010, Scott and Valerie Ronning divorced.

Examination and notices of deficiency

      The Ronnings’ 2005-2008 tax returns came under examination by the

respondent. The examination was conducted by Revenue Agent Andre N.

Edmond. Edmond prepared a civil penalty approval form that covered all four

years. The form had a heading for “Reason(s) for Assertion of Penalty(s)”.

Underneath was written: “Revenue agent asserted accuracy related penalty as it is

believed that taxpayers were negligent”. On the form, Edmond checked a “Yes”

box for negligence for the section 6662(a) penalty. There were other boxes on the

form that corresponded to other potential causes of underpayments specified in
                                       -13-

[*13] section 6662(b). These other boxes were checked “No”. The civil penalty

approval form was signed by Edmond’s immediate supervisor on April 15, 2011.

      The notices of deficiency, issued June 30, 2011, determined deficiencies for

2005, 2006, 2007, and 2008. One notice of deficiency was for 2005 through 2007.

The other was for 2008.

      For 2007, the only noncomputational adjustment in the notice of deficiency

was to reduce to zero the cost of goods sold reported on the Schedule C for

Atlanta Site Consultants, LLC. There were no adjustments to the gross receipts or

business-expense deductions reported on that Schedule C.

      For 2007, the notice of deficiency made no adjustments to Schedule E.

      As a computational result of the disallowance of cost of goods sold for the

2007 Schedule C of Atlanta Site Consultants, LLC, the notice of deficiency

determined that the NOL for 2007 was eliminated. This in turn resulted in the

elimination of NOL carrybacks to 2005 and 2006 and NOL carryforward to 2008.

The corresponding deductions for the NOL carrybacks and carryforward were

disallowed by the notices of deficiency. Besides the disallowance of the

NOL-carryback deductions for 2005 and 2006, the notice of deficiency made no

other adjustments for 2005 and 2006.
                                        -14-

[*14] For 2008, the notice of deficiency determined that the Ronnings failed to

report gross income of $323,569. The notice of deficiency also determined that

the business-expense deductions for Valerie Ronning’s Schedule C business were

$46,548, not the $187,749 amount reported. These two adjustments were the only

noncomputational adjustments made by the notice of deficiency for 2008.

      The notices of deficiency determined to impose section 6662(a) penalties

for both 2007 and 2008.

      For 2007, the notice of deficiency stated that there was an underpayment of

tax that was due to three alternative causes: negligence, substantial

understatement of income tax, or substantial valuation misstatement.

      For 2008, the notice of deficiency also stated that there was an

underpayment of tax that was due to three alternative causes: negligence,

substantial understatement of income tax, or substantial valuation misstatement.

The statement was:
                                         -15-

[*15] 20 Percent Penalty--Internal Revenue Code Section 6662(a)

             It has been determined that the underpayment of tax shown on
             line 7 below is attributable to one or more of the following:

             (1) Negligence or disregard of rules or regulations;
             (2) Substantial understatement of income tax;
             (3) Substantial valuation misstatement (overstatement).

      Therefore, an addition to tax is imposed as provided by Section
      6662(a) of the Internal Revenue Code.

A page later, the notice of deficiency for 2008 clarified that the cause of the

underpayment for 2008 was substantial understatement of income tax. This

statement was:

       2008--Adjustments Subject to Accuracy-Related Penalty--IRC 6662
         ADJUSTMENTS TO WHICH THE ACCURACY RELATED
                             PENALTY APPLIES:
                             PENALTY RATES
                                       20% 40%
      Sch C1 - Gross Receipts or Sales X        323,569.00 IRC 6662(d)

      The notice of deficiency did not determine a section 6662(a) penalty for

2005 or 2006.

Filing of Tax Court petition; death; and substitution of party

      In September 2011, Scott Ronning timely filed the Tax Court petition. His

mailing address was in Wisconsin when he filed the petition.

      In 2012, Scott Ronning died in a car accident in Florida.
                                          -16-

[*16] Harlan L. Paul was appointed by a Florida court as the personal

representative of Scott Ronning’s probate estate. We substituted Paul for Scott

Ronning as the petitioner. See Rule 63(a).

                                       OPINION

         The general rule is that the taxpayer bears the burden of proof. See Rule

142(a)(1). Section 7491(a) provides an exception to this general rule. The

petitioner does not argue that this exception is applicable. Nor does the record

show that this exception is applicable. Therefore, the petitioner has the burden of

proof.

1.       Cost of goods sold for Atlanta Site Consultants, LLC, for 2007

         a.    Exhibit 13-J

         The petitioner hired Michael Thompson, a CPA with experience in forensic

accounting, to reconstruct the records of Scott Ronning’s business. The petitioner

issued Tax Court trial subpoenas to banks that he thought had records regarding

Scott Ronning’s business. The petitioner received bank records in response to the

subpoenas. The trial record does not contain a complete copy of the bank records

that the petitioner received in response to the subpoenas.
                                        -17-

[*17] Thompson assembled a packet of material that was admitted at trial as

Exhibit 13-J. Exhibit 13-J contains some, but not all, of the bank records that the

petitioner had received in response to his subpoenas.

      Before trial, the petitioner engaged in settlement negotiations with the IRS

regarding the proper amount of cost of goods sold for 2007. To assist in these

negotiations, the petitioner gave the respondent the material in Exhibit 13-J. After

reviewing the bank records in Exhibit 13-J, the respondent determined that they

proved that various payments had been made in 2007.

      Of the various payments that the respondent considered proven to have been

made in 2007, the respondent determined for the purpose of settlement

negotiations that $962,975 of the payments had been reported as business-expense

deductions on the 2007 Schedule C for Atlanta Site Consultants, LLC. Recall that

the 2007 Schedule C for Atlanta Site Consultants, LLC, reported $1,117,489 of

business-expense deductions. The notice of deficiency made no adjustment to this

amount. The respondent’s review of the bank records did not result in a change in

the respondent’s litigating position regarding this amount. Thus, the IRS does not

dispute that the correct amount of business-expense deductions is $1,117,489.

      Of the various payments that the respondent considered proven to have been

made in 2007, the respondent determined that another $4,117,386 of the payments
                                        -18-

[*18] should be allowed to the Ronnings as a cost-of-goods-sold allowance for

2007. Recall that the 2007 Schedule C for Atlanta Site Consultants, LLC,

reported $7,175,870 of cost of goods sold. The notice of deficiency reduced this

amount to zero. As a result of its analysis of Exhibit 13-J, the respondent

conceded before trial that there should be a cost-of-goods-sold allowance of

$4,117,386.

      b.      Exhibit 14-P and its calculation of expenses

      The Court admitted Exhibit 14-P, which contains Thompson’s computations

of expenses that the petitioner argues must be allowed as cost of goods sold (or

deducted) for 2007. The computations are based on information about 22 debts

reported in Scott Ronning’s bankruptcy petition. See supra pp. 8-11.

      For each of the first 10 of these 22 debts, Exhibit 14-P calculates a 2007

expense exactly equal to the amount of the debt shown in the bankruptcy petition.

For example, the bankruptcy petition refers to a $55,000 debt owed by Scott

Ronning to the Georgia Department of Revenue for “2007 State Income Tax”.

Exhibit 14-P calculates that Scott Ronning incurred a $55,000 expense in 2007,

exactly equal to the amount of the debt reported on the bankruptcy petition.

      For each of the remaining 12 of the 22 debts, Exhibit 14-P calculates an

interest expense that is mathematically computed from the amount of the debt, but
                                        -19-

[*19] is not equal to it. Here is an example. One of the debt entries on the

bankruptcy petition stated that Scott Ronning owed $5,014,272 to Alpharetta

Community Bank for “Personal Guarantee--Atlanta Road Development, LLC”.

The debt was supposedly owing in May 2009, because that is when Scott Ronning

filed his bankruptcy petition. In Exhibit 14-P Thompson estimated that this loan

had been initially made on January 1, 2006. He estimated that the loan had an

interest rate of 9% during 2006, an interest rate of 8% during 2007, and an interest

rate of 6.75% during 2008. Using these interest rates, Thompson computed that

the interest on the loan was $351,212 for 2006, $340,285 for 2007, and $310,085

for 2008. Thus, the total interest on this loan incurred for the years 2006-2008

was $1,001,582, according to Exhibit 14-P. On the basis of this calculation, the

petitioner seeks cost-of-goods-sold allowances (or business-expense deductions)

of $1,001,582 for 2007.

      For the other 11 of the 12 debt entries from which he inferred an interest

expense, Thompson used a method for calculating interest that was similar to his

method for the Alpharetta Community Bank loan. He estimated the date the loan

originated. This estimate of the date appears to be based on information in the

bankruptcy petition. Some of the loan-origination dates Thompson used were on

January 1, 2006. For these particular loans Thompson estimated that interest was
                                         -20-

[*20] incurred every day of the three years 2006 through 2008. Some of the loan-

origination dates estimated by Thompson were in the middle of the three-year

period 2006 through 2008. For these years Thompson estimated that interest was

incurred from the estimated loan-origination date until December 31, 2008. He

applied the same interest rates for all 12 debts (i.e., he used 9% for interest

incurred in 2006, 8% for 2007, and 6.75% for 2008).

      For the last 11 debt entries, the bankruptcy petition shows that Scott

Ronning had a “co-debtor”. For these debts Thompson assumed in his

computations that the debt owed by Scott Ronning was half of the amount listed

on the bankruptcy petition.

      Thompson’s calculations in Exhibit 14-P are based almost entirely on the

information in the bankruptcy petition. For example, the bank records in Exhibit

13-J do not prove or support any of the calculations in Exhibit 14-P. The sole

exception to this statement is that the bank records in Exhibit 13-J contain monthly

billing statements by Alpha Bank & Trust regarding one particular loan from that

bank.5 Thompson used these billing statements to create his estimate of interest

      5
       The statements to do not say who the debtor is. The statements are
addressed to:

      Clairmont Townhomes Atl LLC
                                                                         (continued...)
                                         -21-

[*21] rates (i.e., 9% for 2006, 8% for 2007, and 6.75% for 2008) for the 12 loans

that Thompson assumed gave rise to interest accruals. Thompson did not estimate

an interest expense for the Alpha Bank & Trust loan itself. Nor does the petitioner

claim cost-of-goods-sold allowances (or business-expense deductions) for the

interest on the Alpha Bank & Trust loan even though the loan is listed in the

bankruptcy petition.6

      c.       The petitioner’s litigation position: the $6,454,736 of expenses
               calculated in Exhibit 14-P should be allowed as cost-of-goods-sold
               allowances (or business-expense deductions) for 2007

      The amounts of cost-of-goods-sold allowances (or business-expense

deductions) the petitioner seeks for 2007 are listed in the findings of fact where we

describe the 22 debts listed in the bankruptcy petition. See supra pp. 8-11. As

noted above, the petitioner relies on Exhibit 14-P for the computation of these

amounts. The total amount in Exhibit 14-P is $6,454,736.7


      5
       (...continued)
      Ronald V Morgan
      Scott C Ronning

This might suggest that the debtor was one or more of these addressees.
      6
      The bankruptcy petition described the loan as “Personal Guarantee--
Clairmont Townhomes Atlanta, LLC”.
      7
          Although the sum of the amounts in Exhibit 14-P is $6,454,736, the amount
                                                                      (continued...)
                                         -22-

[*22] Significantly, the petitioner’s litigating position does not rely on Exhibit

13-J. Neither the petitioner’s opening brief nor his answering brief assert that the

Court should consider Exhibit 13-J in determining the appropriate cost-of-goods-

sold allowances (or business-expense deductions) corresponding to the $6,454,736

amount.

      Another aspect of the petitioner’s litigating position relates to the

appropriate year of the cost-of-goods-sold allowances (or business-expense

deductions) he seeks for interest expenses. Exhibit 14-P estimated the amounts of

interest expenses that Scott Ronning incurred during 2006, 2007, and 2008 based

on 12 of the 22 debts. The petitioner contends that these interest expenses give

rise to cost-of-goods-sold allowances (or business-expense deductions) for the tax

year 2007. The petitioner does not explain why interest incurred during all three

years 2006, 2007, and 2008 should affect taxable income for 2007. We need not

consider this aspect of the petitioner’s litigating position in further detail. As

explained later in this opinion, we reject the petitioner’s litigating position

regarding the interest expenses for other reasons. See infra part 1(f)(ii).




      7
        (...continued)
shown in Exhibit 14-P as the sum of the amounts is $6,454,737, due to rounding
or to computational error.
                                         -23-

[*23] Another aspect of the petitioner’s litigating position is that he does not

specify whether any particular expense that makes up the $6,454,736 amount

should be classified as a cost-of-goods-sold allowance as opposed to a business-

expense deduction. For example, the petitioner’s brief explains that “some” of the

expenses comprising the $6,454,736 amount “was cost of goods sold.”8 The

petitioner also seeks “deductions” for unspecified portions of the $6,454,736

amount.

      Another aspect of the petitioner’s litigating position is that he concedes that

any of the particular expenses comprising the $6,454,736 amount--except for the

interest expenses--could have been incurred by a partnership. The petitioner

asserts that Scott Ronning was a partner in whatever partnership incurred the

expenses.

      For the interest expenses, the petitioner makes a different assumption. He

contends that Scott Ronning was the guarantor of the loans giving rise to the

interest obligations, that the loans in question were defaulted on, and that therefore

Scott Ronning was personally liable for the interest that accrued after default.




      8
      Due to a calculation error, the petitioner’s brief refers to the amount as
$7,893,300.
                                       -24-

[*24] Under this assumption, Scott Ronning, not a partnership, incurred the

interest expenses.

      d.     The relationship between (a) the $6,454,736 amount referred to by the
             petitioner in his litigating position and (b) the $4,117,386 amount
             conceded by the respondent

      As explained above, the petitioner takes the position that some of the

amounts comprising the $6,454,736 amount are allowable as cost of goods sold (as

opposed to business-expense deductions). What may require further explanation

is how the $6,454,736 amount the petitioner alleges relates to the $4,117,386

amount the respondent conceded before trial to be a cost-of-goods-sold allowance

for 2007. As the IRS explained in its brief, it believes the $4,117,386 amount is

payments actually made by Atlanta Site Consultants, LLC, during 2007. By

contrast, none of the amounts comprising the $6,454,736 alleged by the petitioner

are amounts that were actually paid. Under the petitioner’s theory, these amounts

were incurred but not paid. Therefore, there appears to be no overlap between the

$6,454,736 amount (because it comprises unpaid amounts) and the $4,117,386

amount (because it comprises paid amounts). Thus, were we to find that there

should be a cost-of-goods-sold allowance (or a deduction) for any of the amounts

comprising the $6,454,736 amount, that would mean that we would not be giving
                                         -25-

[*25] a tax benefit that had already been accounted for in the IRS’s cost-of-goods-

sold concession.

      e.     The relationship between (a) the $6,454,736 amount referred to by the
             petitioner in his litigating position and (b) the $1,117,489 reported on
             the 2007 Schedule C for Atlanta Site Consultants, LLC

      What is not as clear is the relationship between the $6,454,736 amount

alleged by the petitioner and the $1,117,489 of expenses reported on the 2007

Schedule C for Atlanta Site Consultants, LLC. This $1,117,489 reported amount

was not challenged by the IRS in the notice of deficiency or at trial. Furthermore,

the respondent determined, when it analyzed the bank records in Exhibit 13-J, that

most of the $1,117,489 in reported expenses (i.e., $962,975) were traceable to

actual payments by Atlanta Site Consultants, LLC.9 This would distinguish these

traceable amounts from the amounts comprising the $6,454,736, which the

petitioner alleges are unpaid. This might suggest that there is not much overlap

between the $6,454,736 amount and the $1,117,489 of expenses reported on the

2007 Schedule C for Atlanta Site Consultants, LLC. To further defuse the notion

that there might be an overlap, the petitioner attempted at trial to prove that none


      9
       As explained later in this part 1(e), it is unnecessary for us to determine
what significance, if any, the Court should accord to the respondent’s
determination that $962,975 of payments reflected in the bank records were
reported on the 2007 Schedule C for Atlanta Site Consultants, LLC.
                                       -26-

[*26] of the amounts comprising the $6,454,736 had been reported on the 2007

Schedule C for Atlanta Site Consultants, LLC. To do this, the petitioner called as

a witness Gambrell, the CPA who prepared the Ronnings’ 2007 return. Gambrell

testified that none of the amounts comprising the $6,454,736 had been reported as

business-expense deductions on the 2007 Schedule C for Atlanta Site Consultants,

LLC. If Gambrell is to be believed, then there is no overlap between the

$6,454,736 amount argued by the petitioner on brief and the $1,117,489 of

expenses reported as deductions on the Schedule C. And were we to find that

there should be cost-of-goods-sold allowances (or business-expense deductions)

for the amounts in Exhibit 14-P, that would not mean that we would be giving a

tax benefit that had already been accounted for on the Schedule C. We need not

resolve whether any of the $6,454,736 was reported as a business-expense

deduction on the Schedule C. This is because, as we explain infra part 1(f), even

if no portion of the $6,454,736 amount was reported on the Schedule C, no cost-

of-goods-sold allowances (or business-expense deductions) should be made for

any of the amounts comprising the $6,454,736 estimate.
                                        -27-

[*27] f.     Correct tax treatment of the $6,454,736 of alleged expenses

      For analytical purposes, we divide the $6,454,736 of expenses calculated in

Exhibit 14-P into two groups. The first group corresponds to expenses derived

from the first 10 of the 22 debts listed in the bankruptcy petition that Thompson

relied on in Exhibit 14-P. The second group corresponds to interest expenses

derived from the last 12 of the 22 debts Thompson relied on in Exhibit 14-P.

             i.    Expenses related to the first 10 of the 22 debts listed in the
                   bankruptcy petition

      As we explained, the petitioner admits that the expenses based on the first

10 of the 22 debts could have been incurred by a partnership.10 The petitioner

      10
         The petitioner describes the entities that supposedly incurred the expenses
as follows: “[T]hese companies were owned by either Petitioner or ASC [i.e.,
Atlanta Site Consultants, LLC], and thus should flow to Petitioner via Schedule C
or K-1 either directly to Petitioner or indirectly via ASC”. Subsumed within this
description are several alternative theories of how the expenses calculated in
Exhibit 14-P affect Scott Ronning’s 2007 income. Here are the alternative
theories: (1) the expenses were incurred by a disregarded entity owned by Scott
Ronning, (2) the expenses were incurred by a disregarded entity owned by Atlanta
Site Consultants, LLC (which as we have found is itself a disregarded entity),
(3) the expenses were incurred by a partnership (or an LLC treated as a
partnership) partly owned by Scott Ronning, and (4) the expenses were incurred
by a partnership (or an LLC treated as a partnership) partly owned by Atlanta Site
Consultants, LLC. The petitioner has the burden of proof. See supra p. 16. The
record does not show that any entity that could have incurred the Exhibit 14-P
expenses was a disregarded entity instead of a partnership. It is therefore
appropriate to assume that the entity that incurred the expense is a partnership.
This assumption is also appropriate given the petitioner’s position on brief, which
                                                                        (continued...)
                                         -28-

[*28] does not take a position on whether these expenses should be computed

through a cost-of-good-sold allowance or should be deducted from gross income.

We will consider the propriety of both potential tax treatments. We start with the

calculation of a cost-of-goods-sold allowance.

                    (1)   Cost of goods sold

      For taxpayers who use an inventory method of accounting, a cost-of-goods-

sold allowance is calculated for each year. Cost of goods sold is reflected in gross

income as a reduction. Sec. 1.61-3, Income Tax Regs. The formula for cost of

goods sold is essentially as follows: cost of beginning inventory + costs of

purchases and production ! cost of ending inventory. Huffman v. Commissioner,

126 T.C. 322, 324 (2006), aff’d, 518 F.3d 357 (6th Cir. 2008). Under certain

circumstances, the costs in the formula may be calculated not from actual costs but

from values of the relevant assets. W.C. & A.N. Miller Dev. Co. v.

Commissioner, 81 T.C. 619, 633-634 (1983).




      10
        (...continued)
admits this possibility. Thus, we do not analyze theories (1) and (2), theories in
which Scott Ronning or Atlanta Site Consultants, LLC, owned a disregarded
entity. We are left with theories (3) and (4), theories in which Scott Ronning or
Atlanta Site Consultants, LLC, owned an interest in a partnership. For the sake of
simplicity, we assume that the petitioner’s operative theory is theory (3), i.e., that
Scott Ronning owned an interest in a partnership that incurred the expense.
                                        -29-

[*29] The petitioner concedes that the expenses calculated in Exhibit 14-P could

have been incurred by a partnership or partnerships. Thus, calculating the cost-of-

goods-sold allowance requires us to determine the partnership’s beginning

inventory for 2007, the ending inventory for 2007, and the cost of purchases and

production for 2007.

      But we do not know which partnership or partnerships incurred any

particular expense calculated in Exhibit 14-P corresponding to the first 10 of the

22 debts. It follows that we do not know the relevant partnership’s beginning

inventory for 2007, ending inventory for 2007, and cost of purchases and

production for 2007. Thus, we cannot calculate cost of goods sold using the

formula stated above. It follows that computationally we cannot use the formula

to determine that there is a cost-of-goods-sold allowance attributable to the

expenses calculated in Exhibit 14-P corresponding to the first 10 of the 22 debts.

      Besides the cost-of-goods-sold formula, another inventory method of

accounting is the specific identification method. W.C. & A.N. Miller Dev. Co. v.

Commissioner, 81 T.C. at 631-634. Under the specific identification method of

accounting, the taxpayer matches an item of inventory that has been sold during

the year with the cost of acquiring or producing that particular item of inventory.

Fox Chevrolet Inc. (Md.) v. Commissioner, 76 T.C. 708, 722 (1981) (“When
                                         -30-

[*30] practical, the specific identification method can be used whereby sales

proceeds are matched with the actual cost (or other valuation) of the specific item

sold.”). The cost of goods sold for that particular sale is the cost of acquiring or

producing that particular item of inventory. As with the formula for cost of goods

sold, under certain circumstances the value of an asset can be used instead of its

actual cost. Id.; W.C. & A.N. Miller Dev. Co v. Commissioner, 81 T.C. at 633

(“[A] departure from the actual cost of the particular items sold takes place.”).

The specific identification method requires the taxpayer to have a record of the

cost of each particular product (or its value under certain instances). Here, the

taxpayer is a partnership, the identity of which we are unaware. It follows that we

do not have the records necessary to match the expenses in Exhibit 14-P with any

particular item of inventory sold by the partnership. Computationally, we cannot

use the specific identification method to determine that there is a cost-of-goods

allowance attributable to these expenses either.

      Moreover, it appears that the partnership that incurred any particular

expense in Exhibit 14-P would not be the type of taxpayer that is permitted to use

an inventory method of accounting. Scott Ronning, and presumably the

partnership or partnerships that incurred the expenses in Exhibit 14-P, was in the

business of real-estate development. The income from a business of selling land
                                        -31-

[*31] and the improvements to land cannot be computed under an inventory

method of accounting. Homes by Ayres v. Commissioner, 795 F.2d 832 (9th Cir.

1986), aff’g T.C. Memo. 1984-475; W.C. & A.N. Miller Dev. Co v.

Commissioner, 81 T.C. at 629; Atl. Coast Realty Co. v. Commissioner, 11 B.T.A.

416 (1928); sec. 1.471-1, Income Tax Regs. (inventories must be used by taxpayer

who produces, buys, or sells merchandise). For such businesses, the appropriate

method of accounting is the “capitalization” method whereby the gain or loss on

the sale of an asset is generally computed by subtracting the actual cost of the

asset from its sale price. W.C. & A.N. Miller Dev. Co v. Commissioner, 81 T.C.

at 631-632; see Boris I. Bittker & Lawrence Lokken, 4 Federal Taxation of

Income, Estates and Gifts, para. 105.8.1, at 105-129 (2d ed. 1992) (“[I]nventory

accounting may not be used by a dealer in or developer of real property, but the

costs of each item sold are instead subtracted in computing gross income from the

sale.”). There is a difference between (1) the capitalization method of accounting

and (2) the specific identification method of inventory accounting. Under the

capitalization method of accounting, actual cost must be used. W.C. & A.N.

Miller Dev. Co v. Commissioner, 81 T.C. at 632-633. Under the specific

identification method of inventory accounting, value can be used instead of actual

cost under certain circumstances. Id. Other than this difference, the two methods
                                         -32-

[*32] reach similar results. Id. at 631 (“There is, as acknowledged by respondent,

a method of inventory accounting known as the specific identity method which is

virtually identical in operation to capitalization. See R. Hoffman & H. Gunders,

Inventories-Control, Costing and Effect Upon Income and Taxes 119-120 (1970

ed.); W. Meigs, C. Johnson & R. Meigs, Accounting: The Basis for Business

Decisions 374-375 (4th ed. 1977).”).

        Under the capitalization method, none of the expenses calculated in Exhibit

14-P can be recovered in the computation of the 2007 income of the partnership

that incurred the expense. This is because we do not have the records to link any

particular expense calculated in Exhibit 14-P with any asset that was sold during

2007.

        In summary, the record in this case precludes us from concluding that the

expenses calculated in Exhibit 14-P affect the income of whatever partnership or

partnerships incurred the expenses.

        Now let us suppose, to the contrary, that the expenses calculated in Exhibit

14-P did affect the income of the partnership or partnerships that incurred the

expenses. Even then we would need to consider the effect on Scott Ronning’s

income. A partnership is not subject to federal income tax. Sec. 701. Rather, the

income, losses, and deductions of a partnership are passed through to its partners
                                         -33-

[*33] and are based on each partner’s distributive share. Sec. 702(a). A partner’s

distributive share of the partnership’s income, losses, and deductions is

determined under rules set forth in section 704. We do not know facts necessary

to determine Scott Ronning’s relevant distributive share for the partnership or

partnerships that incurred the expenses calculated in Exhibit 14-P. We do not

know which partnership or partnerships incurred the expenses, and the record does

not reveal Scott Ronning’s distributive share for any partnership whatsoever.

      Another problem with calculating the effect on Scott Ronning’s income is

the outside-basis limitation of section 704(d). That provision states: “A partner’s

distributive share of partnership loss (including capital loss) shall be allowed only

to the extent of the adjusted basis of such partner’s interest in the partnership”.

Even if we could determine Scott Ronning’s relevant distributive share for a

particular partnership, we do not know his outside basis in the partnership. See

O’Neill v. Commissioner, 271 F.2d 44, 50 (9th Cir. 1959) (“Proof of basis is a

specific fact which the taxpayer has the burden of proving.”), aff’g T.C. Memo.

1957-193.

                    (2)   Deductions

      We now consider the effect on Scott Ronning’s taxable income if one of the

first group of expenses should be allowed as a deduction for 2007. Such a
                                        -34-

[*34] deduction would initially be computed in the taxable income of the

partnership. See sec. 703(a). To determine the effect of the deduction on Scott

Ronning’s taxable income, we would need to know Scott Ronning’s distributive

share of the deduction. See sec. 702(a)(7). We would also need to know his

outside basis in the partnership. See sec. 704(d). Again, the petitioner has proven

none of these things.

             ii.   Expenses related to the last 12 of the 22 debts listed in the
                   bankruptcy petition

      The second group of the $6,454,736 in alleged expenses is interest

expenses. The petitioner asserts that the debts that allegedly generated the interest

expenses were defaulted on and that Scott Ronning became obligated to pay the

debts (and interest on the debts) through a guaranty. The petitioner does not take a

position on whether these expenses affect the computation of a cost-of-goods-sold

allowance or should be deducted from gross income. We consider both potential

tax treatments.

                   (1)    Cost of goods sold

      We start with the effect of the interest expenses on the calculation of a cost-

of-goods-sold allowance. To the extent an inventory method of accounting is even

applicable, we do not know beginning inventory for 2007, ending inventory for
                                         -35-

[*35] 2007, or cost of purchases and production for 2007; and we cannot match a

particular interest expense to a particular item of inventory or asset. Therefore we

conclude that no cost-of-goods-sold allowance should be made for the interest

expenses calculated in Exhibit 14-P.

                    (2)   Deductions

      The petitioner’s theory is that the year for which the interest deductions

should be allowed is “the December 31, 2007 tax year”, meaning 2007. The

taxpayer’s method of accounting determines for what year the taxpayer is entitled

to a deduction. Sec. 461(a) (“The amount of any deduction or credit allowed by

this subtitle shall be taken for the taxable year which is the proper taxable year

under the method of accounting used in computing taxable income.”). One

method of accounting is the cash method. Sec. 1.446-1(c)(1)(i), Income Tax Regs.

Under the cash method, the taxpayer claims deductions for the year in which the

amount representing the deduction is paid. Sec. 1.461-1(a)(1), Income Tax Regs.

Here the amount representing the deduction is an interest charge. A cash-method

taxpayer cannot deduct interest until the interest is paid. See Ronald Moran

Cadillac, Inc. v. United States, 385 F.3d 1230, 1235 (9th Cir. 2004) (“Under the

cash accounting method, the taxpayer may deduct interest only when it is paid.”

(citing section 1.461-1(a)(1), Income Tax Regs.)). Another method of accounting
                                         -36-

[*36] is the accrual method. Sec. 1.446-1(c)(1)(ii), Income Tax Regs. Under the

accrual method, the taxpayer claims a deduction for the year in which the liability

is incurred. Sec. 1.461-1(a)(2), Income Tax Regs. Here the liability in question is

an interest charge. An accrual-method taxpayer can deduct interest which has

been accrued even though unpaid. Cohen v. Commissioner, 21 T.C. 855 (1954).

      Scott Ronning used the cash method of accounting for 2007. Or at least, the

petitioner has not proven otherwise.11 The interest accruals hypothesized by

Thompson in Exhibit 14-P were never paid. Therefore, they cannot provide a

ground for a deduction for a taxpayer using the cash method. See, e.g., DeVoe v.

Commissioner, T.C. Memo. 1986-477 (a cash-basis taxpayer cannot deduct unpaid

interest), aff’d, 860 F.2d 1088 (9th Cir. 1988).

      In our view, the possibility that Scott Ronning was a cash-method taxpayer

is sufficient grounds for denying the interest deductions.

      In addition, we hold that even if Scott Ronning was an accrual-method

taxpayer, there is insufficient proof that he is entitled to an interest expense

deduction. An interest expense deduction is justified, if at all, under section


      11
         Although a taxpayer who derives income from the production, purchase,
or sale of merchandise must use the accrual method of accounting for those
activities, sec. 1.446-1(a)(4)(i), (c)(2)(i), Income Tax Regs., the preponderance of
the evidence does not show that Scott Ronning engaged in this type of activity.
                                         -37-

[*37] 163(a), which provides: “There shall be allowed as a deduction all interest

paid or accrued within the taxable year on indebtedness.” The petitioner’s theory

is that the 12 debts listed in the bankruptcy petition were initially owed by various

entities with Scott Ronning as the guarantor, that the debts were defaulted on by

the primary obligors, and that Scott Ronning became liable for the debts (and the

interest on the debts) by the beginning of 2007. Thus, according to the petitioner’s

theory, Scott Ronning was entitled to deductions for interest accrued during 2007.

      It appears to be true, as a matter of legal theory, that a guarantor of a debt

may deduct interest once the primary obligor has defaulted. See, e.g., Gregersen

v. Commissioner, T.C. Memo. 2000-325, slip op. at 4-6; Tolzman v.

Commissioner, T.C. Memo. 1981-689, 43 T.C.M. (CCH) 1, 7 (1981). Before

default occurs, however, the guarantor may not deduct interest. Rushing v.

Commissioner, 58 T.C. 996 (1972). This is so because a taxpayer may deduct

interest only on the taxpayer’s own debts. Id. at 1000. Before there is a default,

the debt is that of the primary obligor, not the guarantor. Id.

      Thus, one factual condition that must be true is that the 12 debts listed in the

bankruptcy petition must have been defaulted on by the end of 2007. There is

credible evidence in the record that as a general matter Scott Ronning’s real-estate

business was doing badly during 2007. However, this is not the same thing as
                                           -38-

[*38] proof that any of the particular 12 debts was defaulted on by the end of

2007. There is very little evidence in the record about these 12 debts. The

primary evidence about the debts is that Scott Ronning claimed on the bankruptcy

petition, filed in 2009, that he owed the debts through a “PERSONAL

GUARANTEE”. This is not the same thing as proof that by the end of 2007 the

primary obligor on the debts had defaulted and that Scott Ronning had become

liable for the debts as their guarantor.

      The lack of proof of the date of default is therefore another reason no

interest deduction is allowable for the interest on the 12 debts.

      g.     Conclusions and some other considerations

      Given our analysis set forth supra part 1(f), we conclude that the cost-of-

goods-sold allowance is no greater than the $4,117,386 amount conceded by the

respondent. We also conclude that no business-expense deduction should be

allowed beyond the $1,117,489 reported on the Schedule C for Atlanta Site

Consultants, LLC. In making these conclusions, we have considered other factors

that we have not yet discussed. We discuss these factors below.

             i.     The principle that a taxpayer can reconstruct income

      The petitioner argues that a taxpayer is entitled to reconstruct income when

the taxpayer’s records are destroyed through no fault of his own. He cites for this
                                          -39-

[*39] proposition Bell v. Commissioner, T.C. Memo. 2011-296, 102 T.C.M.

(CCH) 609, 611 (2011), in which we stated: “When a taxpayer’s records are lost

or destroyed through circumstances beyond his control, the taxpayer is entitled to

substantiate deductions by reconstructing expenditures through credible

evidence.” The petitioner contends that Scott Ronning’s illness resulted in the

destruction of the business records. Therefore, the petitioner contends that they

were destroyed through circumstances beyond Scott Ronning’s control.

      In our view, the evidence shows that the records were lost before Scott

Ronning’s illness. Therefore we disagree with the petitioner’s factual proposition

that the records were destroyed for reasons outside Scott Ronning’s control.

Anyway, we have considered all the reconstructed records that the petitioner

introduced at trial. In our view, these reconstructed records, fully considered, do

not establish the petitioner’s litigating position.

             ii.    The possibility that the interest expenses were incurred before
                    the loans were defaulted on rather than after

      The second group of expenses, as explained above, consists of interest

expenses supposedly incurred by Scott Ronning after the original obligor on a loan

defaulted on the loan, a default that supposedly triggered Scott Ronning’s liability

as the guarantor. The evidence does not actually show which particular loans were
                                         -40-

[*40] defaulted on or the dates of default. This might suggest that there is a

possibility that the original obligor did not default and that the interest was

incurred by the original obligor, not by Scott Ronning as the guarantor of the loan.

In such a situation, Scott Ronning would get cost-of-goods-sold allowances (or

business-expense deductions) for the accrued interest only if the obligor of the

loan was a partnership in which Scott Ronning is a partner.12 Even in this

situation, Scott Ronning would not be entitled to a cost-of-goods-sold allowance

(or deduction) for the reasons given supra part 1(f)(i)(1), i.e., lack of proof of

distributive share and outside basis.

             iii.   The identity of the partnership or partnerships that may have
                    incurred the expenses calculated in Exhibit 14-P

      We discussed supra part 1(f)(i) the expenses calculated in Exhibit 14-P as

having been incurred by an unidentified partnership or partnerships. We did not

consider the possibility that the expenses were incurred by one of the four

particular entities listed as partnerships on the Ronnings’ Schedule E for 2007.

Nor did we consider the possibility that the expenses were incurred by one of the




      12
       Although the cost-of-goods-sold allowances (or business-expense
deductions) would also be available if the obligor was a disregarded entity wholly
owned by Scott Ronning, the petitioner has not proven that any of the loans were
made to disregarded entities wholly owned by Scott Ronning.
                                         -41-

[*41] 21 particular partnerships that were listed by Scott Ronning in his

bankruptcy petition as entities in which he had ownership interests.

      Although we found that Scott Ronning conducted his real-estate-

development business through one or more partnerships, we could not identify

which entity or entities these were. The mere fact that the four entities were

reported on the 2007 Schedule E or that the 21 entities were listed on the

bankruptcy petition does not mean the entities existed. There are several reasons

we say this. First, the return preparation for 2007 was shoddy. The return

preparer--Gambrell--filled out the return using a document called a “trial balance”.

The trial balance itself is not in the record. Gambrell’s testimonial description of

the trial balance indicates that the trial balance was inadequate and incomplete as a

report of Scott Ronning’s income. Second, we are not convinced that the entities,

even if they existed in form, had any substance or conducted any business activity.

The petitioner admits on brief that the corporate structure is uncertain. He says

that “the revenues and expenses of the other companies” were “run through ASC”.

Third, the petitioner does not propose in his findings of fact that any particular

entity existed or that Scott Ronning had an ownership interest in any particular

entity. The only exception is Atlanta Site Consultants, LLC. The petitioner

asserted that this entity existed, that it was owned by Scott Ronning, and that it
                                        -42-

[*42] was a disregarded entity for federal tax purposes. The respondent did not

object to these characterizations.

      In any event, even if we held or assumed that the expenses calculated in

Exhibit 14-P were incurred by any entity named in the 2007 Schedule E or the

bankruptcy petition, this would not change our conclusion. The record contains

no evidence of any such entity’s beginning inventory, ending inventory, or

purchase or acquisition amounts. Nor does the record contain evidence of Scott

Ronning’s distributive share or outside basis.

2.    NOL

      A taxpayer’s NOL for a tax year is the excess of the taxpayer’s deductions

over gross income. Sec. 172(c). Unless an exception applies, the NOL for a tax

year is carried back to the prior two tax years and is a deduction for each of those

two years. Sec. 172(b)(1)(A)(i). Any remaining NOL is carried forward to years

after the year of the NOL and is a deduction for each of those later years. Sec.

172(b)(1)(A)(ii).

      When the Ronnings reported their NOL on their 2007 return, their

computation of the NOL included the $7,175,870 cost of goods sold reported on

the 2007 Schedule C for Atlanta Site Consultants, LLC. In part 1 we held that the

cost of goods sold is instead $4,117,386. The computational results of this
                                         -43-

[*43] holding are as follows: (1) there is no NOL for 2007, (2) there is no NOL

carryback to 2005 and 2006, and (3) there is no NOL carryforward to 2008. The

determinations in the notices of deficiency disallowing the NOL-carryback

deductions for 2005 and 2006 and disallowing the NOL-carryforward deduction

for 2008 are therefore sustained.

3.    Gross income for 2008

      The notice of deficiency determined that the Ronnings did not report

$323,569 of gross income for 2008. Scott Ronning’s Tax Court petition stated

that this determination was erroneous. In its opening brief, the respondent

conceded that the amount of unreported gross income is $323,566. This is three

dollars less than the corresponding amount determined in the notice of deficiency.

In the petitioner’s answering brief, he agreed with that amount. We hold that the

amount of unreported gross income for 2008 is $323,566.

4.    Business-expense deductions for 2008 for Valerie Ronning’s business

      Valerie Ronning was a real-estate agent during 2008. Attached to the

Ronnings’ 2008 return was a Schedule C for her business. The Schedule C

reported business-expense deductions of $187,749. The notice of deficiency

determined that the correct amount was $46,548. Scott Ronning’s Tax Court

petition stated that this determination was in error. In its opening brief, the
                                         -44-

[*44] respondent contended that the petitioner did not substantiate any deductible

expenses beyond this amount. In his answering brief, the petitioner agreed. We

hold that the correct amount of business-expense deductions is $46,548.

5.    Penalties

      Section 6662(a) imposes a 20% penalty on the portion of an underpayment

of tax that is attributable to any of the various causes set forth in section 6662(b).

These causes include negligence, substantial understatement of income tax, and

substantial valuation misstatement. No section 6662(a) penalty is imposed on the

portion of an underpayment for which there is reasonable cause and good faith.

Sec. 6664(c)(1). In general, the section 6662(a) penalty can be imposed only if the

initial determination to assess the penalty is personally approved by the immediate

supervisor of the individual making the determination. Sec. 6751(b)(1); see Graev

v. Commissioner, 149 T.C. 485, 492-493 (2017), supplementing and overruling in

part 147 T.C. 460 (2016); cf., e.g., Walquist v. Commissioner, 152 T.C.___, ___

(slip op. at 14-21) (Feb. 25, 2019) (penalties determined under section 6662(a) and

(b)(2) by an IRS computer program without human review are “automatically

calculated through electronic means” within the meaning of section 6751(b)(2)(B)

and thus exempt from the written supervisory approval requirement under section

6751(b)(1)).
                                       -45-

[*45] a.    2007

      For tax year 2007, the notice of deficiency determined an underpayment due

to three alternative causes: negligence, substantial understatement of income tax,

or substantial valuation misstatement. The preponderance of the evidence shows

that the section 6662(a) penalty was supervisor-approved for only one of these

causes: negligence. Thus, we need consider only whether the underpayment of

tax for 2007 was attributable to negligence.

      The petitioner does not contest that if there is an underpayment for 2007,

such underpayment is due to negligence. Nor does he argue that there is

reasonable cause for any portion of the underpayment for 2007. We therefore

sustain the respondent’s determination to impose the section 6662(a) penalty for

2007. The amount of the underpayment, and therefore the amount of the penalty,

will be determined under Rule 155.

      b.    2008

      For tax year 2008, the notice of deficiency contained the boilerplate

statement that there is an underpayment due to three alternative causes:

negligence, substantial understatement of income tax, or substantial valuation

misstatement. See McGuire v. Commissioner, 149 T.C. 254, 262-263 (2017);

Ocampo v. Commissioner, T.C. Memo. 2015-150, at *52. The notice of
                                        -46-

[*46] deficiency then clarified that the underpayment was determined to be due to

a substantial understatement of income tax. Because the notice of deficiency

determined that the underpayment for 2008 was due to one cause--a substantial

understatement of income tax--the question to be considered is whether imposition

of the section 6662(a) penalty for a substantial understatement had been

supervisor-approved. See Palmolive Bldg. Inv’rs, LLC v. Commissioner, 152

T.C. ___, ___ (slip op. at 19) (Feb. 28, 2019).

      The preponderance of the evidence shows that the section 6662(a) penalty

had been supervisor-approved only for negligence. It had not been

supervisor-approved for a substantial understatement. Therefore, section 6751(b)

bars the respondent from imposing the section 6662(a) penalty for 2008. The

amount of the liability for the section 6662(a) penalty for 2008 is zero.

      To reflect the foregoing,


                                               Decision will be entered

                                       under Rule 155.
