                               T.C. Memo. 2015-31



                        UNITED STATES TAX COURT



            PARESH M. SHAH AND RITA P. SHAH, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

               K. DIPAL ENTERPRISES, INC., Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket Nos. 19071-12, 19072-12.              Filed February 25, 2015.



      Paresh M. Shah and Rita P. Shah, pro sese.

      Paresh M. Shah (an officer), for K. Dipal Enterprises, Inc.

      Alissa L. VanderKooi and Alicia A. Mazurek, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      BUCH, Judge: Petitioner Paresh M. Shah engaged in various activities for

which he neither sought nor derived any revenue, yet he and his wife, Dr. Rita P.
                                        -2-

[*2] Shah, claimed deductions for expenses that they attributed to those activities.

Mr. Shah also operated K. Dipal Enterprises, Inc. (K. Dipal), a computer

consulting business. The Internal Revenue Service (IRS) disallowed some of the

expenses that the Shahs deducted personally or through K. Dipal because those

expenses were wholly personal or because neither the Shahs nor K. Dipal could

substantiate them. The IRS also determined that K. Dipal did not report all of its

income. Because taxpayers generally cannot deduct personal expenses,1 and

because the Shahs and K. Dipal failed to substantiate expenses beyond those

respondent allowed, we sustain respondent’s determinations. We also sustain

respondent’s determinations of K. Dipal’s unreported income and the imposition

of accuracy-related penalties.

                                 FINDINGS OF FACT

      Mr. Shah and Dr. Shah were married during 2009 and 2010 and filed joint

Federal income tax returns for those years.




      1
       Sec. 262(a). Unless otherwise indicated, all section references are to the
Internal Revenue Code (Code) in effect for the years in issue, and all Rule
references are to the Tax Court Rules of Practice and Procedure. All monetary
amounts are rounded to the nearest dollar.
                                           -3-

[*3] I.         Dr. Shah’s Activities

          Dr. Shah works as an internist at Michigan Physicians Group. Mr. Shah’s

brother and sister are also doctors at Michigan Physicians Group. During 2009

and 2010 this group had at least seven physicians and five office locations.

II.       Mr. Shah’s Activities

          Mr. Shah participates in various activities, both individually and through an

entity, K. Dipal, including information technology (IT), consulting, financial

management, and real estate. Mr. Shah has a bachelor’s degree in chemical

engineering and a master’s degree in computer science.

          A.    IT Business Operated Through K. Dipal

          Mr. Shah operates an IT and computer consulting business and reported this

both personally on a Schedule C, Profit or Loss From Business, and through a

corporate entity, K. Dipal. K. Dipal has only one client, Michigan Physicians

Group. Although K. Dipal does not have a contract, it was the sole IT service

provider for Michigan Physicians Group for 2009 and 2010. K. Dipal maintained

Michigan Physicians Group’s computer servers, Web site, electronic medical

records, database, computers, printers, software, phones, and other electronic

office equipment for more than 10 years. Mr. Shah was also involved in

management, database design, data analysis, and system design. Michigan
                                        -4-

[*4] Physicians Group paid K. Dipal $12,000 per month for these services. Mr.

Shah was K. Dipal’s only employee; however, his high-school-age daughter

occasionally helped. In addition, K. Dipal paid for the services of one

independent contractor who helped maintain the equipment, which was owned by

Michigan Physicians Group.

      K. Dipal filed Forms 1120, U.S. Corporation Income Tax Return, for 2009

and 2010.

      B.     Other IT and Computer Consulting Activities

      In addition to performing IT services through K. Dipal, Mr. Shah did IT

work and computer consulting for Michigan Physicians Group and some of his

family members remotely from his home. Although Mr. Shah testified that he had

been trying to get IT clients other than Michigan Physicians Group and his family

members for at least 10 years, he did not have any other clients. And he neither

sought nor received compensation for the IT services he performed from his home

in his individual capacity.

      The Shahs reported all of the expenses related to the IT and computer

consulting activities that Mr. Shah performed from home on Schedules C of their

personal returns instead of on K. Dipal’s corporate returns for the years in issue.
                                        -5-

[*5] They also deducted other related expenses because K. Dipal did not

reimburse Mr. Shah for what he personally spent to support the business.

       C.    Financial Management and Investment Consulting Activities

       For more than 10 years Mr. Shah managed investment portfolios for his

brother and his brother’s two children. He also acted as an investment consultant

to his family members and Michigan Physicians Group on their various

investments. Mr. Shah is not a licensed broker and does not have any clients

except for his family members and Michigan Physicians Group. He has neither

sought nor received compensation for these activities.

       The Shahs reported expenses for these activities for each of the years in

issue on their Schedule C.

       D.    Rental Property

       The Shahs owned a rental property on Woodward Avenue in Bloomfield

Hills, Michigan. The Woodward Avenue property produced rental income during

the years in issue, and the Shahs reported the expenses associated with this

property on their personal return.

III.   Family and Business Expenses Reported on the Shahs’ Individual Returns

       For 2009 and 2010 Mr. Shah prepared the Shahs’ Forms 1040, U.S.

Individual Income Tax Return, and K. Dipal’s Forms 1120.
                                         -6-

[*6] A.      Unreimbursed Employee Expenses

      The Shahs claimed deductions for unreimbursed employee expenses on their

Schedule A, Itemized Deductions, of $13,535 for 2010, and attached the

corresponding Form 2106, Employee Business Expenses. The Shahs reported the

following expenses on their Form 2106: vehicle, travel, meals and entertainment,

and various other business expenses. Dr. Shah testified that these expenses were

for her continuing medical education, but no one recalled her ever seeking

reimbursement from Michigan Physicians Group. The Shahs did not provide any

substantiation for these expenses to the Court.

      B.     IT, Financial Management, and Consulting Activities

      The Shahs reported the principal business activity on their Schedules C for

2009 and 2010 as “FINANCIAL MGT IT CON”. This abbreviation stood for Mr.

Shah’s financial management, IT, and consulting activities.

      The Shahs reported losses on their Schedules C of $21,566 for 2009 and

$32,477 for 2010. The only income that the Shahs reported on Schedule C was

$12,000 for 2009 and $9,600 for 2010, the rental income from their Woodward

Avenue property. The Shahs reported a total of $28,248 in expenses on Schedule

C for 2009 and $33,780 in expenses for 2010 for the following: car and truck,

travel, meals and entertainment, advertising, utilities, interest, legal and
                                       -7-

[*7] professional services, commissions and fees, supplies, taxes and licenses,

other, and depreciation and section 179.2 The Shahs grouped all of the Schedule C

expenses together.

      The car and truck expenses that the Shahs deducted related to the

development of rental property buildings Mr. Shah owned with his brother and to

Mr. Shah’s work for Michigan Physicians Group when he drove between clinic

locations. The Shahs reported these expenses on Schedule C because Mr. Shah

was not reimbursed for them. The Shahs presented a report dated October 21,

2013, that summarized the mileage for his Cadillac CTS for two weeks in

February 2009. This report also showed car lease information, service history, and

the vehicle’s mileage as of January 30, 2009, June 22, 2009, and February 2, 2012;

however, this report did not show the mileage for each trip, the times and dates

driven, the destinations, or the business purpose of each automobile use for 2009

and 2010.

      The Shahs reported business travel expenses of $3,295 for 2009 and $3,735

for 2010 but did not substantiate either the amounts of the expenses or the

business purposes of the travel. Mr. Shah testified that the 2009 travel expenses

      2
       The Shahs also reported expenses on Forms 8829, Expenses for Business
Use of Your Home, for the business use of their home for 2009 and 2010.
Respondent allowed deductions for these expenses in the notice of deficiency.
                                        -8-

[*8] were for a trip Mr. Shah took to Chicago to obtain business advice from his

brother, a commercial and residential broker.

      The Shahs reported meals and entertainment expenses that related to meals

they had with members of their extended family who either worked for Michigan

Physicians Group or who were otherwise connected with Mr. Shah’s activities.

The Shahs did not provide any documents to substantiate either the amounts or the

business purpose of these expenses.

      Although Mr. Shah testified that the advertising expenses the Shahs

reported related to the advertising and Web site development of his various

activities, the Shahs did not provide any documents to substantiate these expenses.

      Similarly, the Shahs reported other expenses on Schedules C that were

further described on the returns as “BOOKS, MAGAZINES, EDUCATION”, but

they did not provide any documents to substantiate these expenses.

      The Shahs did not describe the utility expenses reported on Schedules C,

nor did they provide any documents to substantiate them. These amounts

presumably related to utilities for the Shahs’ personal residence.

      The Shahs did not offer any documents to substantiate the interest, legal and

professional services, commissions and fees, supplies, or taxes and licenses

expenses.
                                        -9-

[*9] Additionally, the Shahs did not substantiate their claimed depreciation and

section 179 expenses. Indeed, at trial Mr. Shah was not sure whether these

expenses were for the Shahs’ Woodward Avenue property or for another property

in Troy, Michigan.

      C.     Rental Property

      The Shahs rented out their Woodward Avenue property for 2009 and 2010;

however, they reported that they placed it into service on June 1, 2010.

Consequently, they included a Schedule E, Supplemental Income and Loss, only

with their 2010 return. The Shahs reported rental income of $12,000 for 2009 and

$9,600 for 2010 on their Schedules C, and for 2010 they duplicated the $9,600 of

income on Schedule E. The Shahs reported expenses of $18,090 on their 2010

Schedule E for the following items: advertising, cleaning and maintenance,

commissions, legal and other professional fees, mortgage interest, repairs,

supplies, taxes, utilities, and depreciation. These expenses resulted in a Schedule

E rental real estate loss of $8,490 for 2010; however, the Shahs did not provide

any documents to substantiate these expenses.

IV.   Family and Business Expenses Reported on K. Dipal’s Corporate Returns

      K. Dipal reported net losses on its 2009 and 2010 Forms 1120 of $33,702

and $17,716, respectively, despite gross receipts for both years of more than
                                        - 10 -

[*10] $158,000. The returns list K. Dipal’s business activities as “Computer or IT

Related Services” and “Consulting and Management” and list Mr. Shah as the

owner of 100% of the voting stock of K. Dipal.

      K. Dipal deducted expenses for the following categories of items: taxes and

licenses, interest, salaries and wages, repairs and maintenance, advertising,

pension and profit sharing, and “other”. K. Dipal did not provide any documents

to substantiate the taxes and licenses, interest, salaries and wages, repairs and

maintenance, advertising, or pension and profit-sharing expenses.

      K. Dipal reported “other expenses” of $98,107 for 2009 and $76,291 for

2010. Mr. Shah referred to these expenses as fringe benefits that K. Dipal

provided to him and his family members. K. Dipal further itemized these other

expenses on its returns into the following categories: training and education,

computer services and supplies, gifts, meals and entertainment, legal and

professional services, utilities, accounting, auto and truck, bank charges, dues and

subscriptions, insurance, laundry and cleaning, outside services and independent

contractors, parking fees and tolls, postage, supplies, telephone, and travel. K.

Dipal did not provide any documents to support these expenses other than a

summary exhibit, but trial testimony further explained these “other expenses”.
                                       - 11 -

[*11] As part of the “other expenses”, K. Dipal reported training and continuing

education expenses for high school tuition payments made to Detroit Country Day

School for the Shahs’ daughter. The Shahs’ daughter helped with filing, computer

work, Quicken, data entry, and posting. Mr. Shah called the tuition payments, like

many of the other K. Dipal deductions, a fringe benefit for his daughter; however,

their daughter was not paid a salary and did not include these tuition payments as

income on a personal income tax return. And as previously noted, K. Dipal did

not offer any documents to substantiate these expenses.

      Other items K. Dipal included in “other expenses” were computer services

and supplies expenses. These expenses were for computer equipment at the

Shahs’ residence, and Mr. Shah used this equipment to remotely support Michigan

Physicians Group. K. Dipal did not offer any documents to substantiate these

expenses.

      Also part of the “other expenses” K. Dipal reported were gift and meal

expenses. Because K. Dipal did business with Mr. Shah’s family members, it

deducted costs for gifts that Mr. Shah gave to his family members and for family

meals. Although the Shahs testified that these meals were business meetings

where Michigan Physicians Group’s IT issues were discussed, K. Dipal did not
                                        - 12 -

[*12] offer any documents to substantiate these expenses or to support the

business nature of these meals.

      For 2009 K. Dipal reported legal and professional services expenses but did

not provide any explanation for them. K. Dipal did not have any contracts for the

years in issue with any attorneys or professionals that would account for these

expenses, nor did K. Dipal provide any documents to substantiate them. Further,

K. Dipal reported utility expenses for cable TV, gas, water, and electricity for the

Shahs’ personal residence as part of the “other expenses” category. These

expenses were for the entire home, not just the 880-square-foot portion that the

Shahs had reported as a home office on their personal returns. K. Dipal did not

offer any documents to substantiate these expenses.

      K. Dipal did not present any evidence to the Court regarding the additional

items categorized on its returns as “other expenses”: accounting, auto and truck,

bank charges, dues and subscriptions, insurance, laundry and cleaning, outside

services and independent contractors, parking fees and tolls, postage, supplies,

telephone, and travel.

      At trial Mr. Shah presented a two-page summary for K. Dipal for the years

in issue dated January 16, 2012, that he had produced using Quicken software.

Mr. Shah testified that he had imported the bank account information into Quicken
                                        - 13 -

[*13] and then used Quicken to generate this summary. The summary showed

totals for K. Dipal’s expenses separated by categories. Examples of the items on

the Quicken summary were: lawn mowing and landscape, education, medical,

household miscellaneous, home repair, retail purchases, travel, meals and

entertainment, automobile, IT equipment, IT, utilities, gifts, and payroll service

charge expenses. Mr. Shah did not present any of the source documents

underlying this summary at trial.

V.    IRS Examination

      The IRS audited the Shahs’ individual returns and K. Dipal’s corporate

returns, making adjustments for both 2009 and 2010.

      A.     Shahs’ Individual Audit

      Respondent sent a notice of deficiency on May 2, 2012, to the Shahs for

2009 and 2010 that determined the following deficiencies and penalties:

                                                                   Penalty
           Year                      Deficiency                  sec. 6662(a)
           2009                        $6,102                       $1,220
           2010                        11,665                        2,333
                                        - 14 -

[*14] In the notice respondent disallowed most of the Schedules A, C, and E

expense deductions on the Shahs’ individual returns, determined accuracy-related

penalties, and made other computational adjustments.

      B.     K. Dipal Corporate Audit

      Respondent issued K. Dipal a notice of deficiency on May 2, 2012, for 2009

and 2010. In the notice respondent made the following adjustments: increased K.

Dipal’s income, disallowed many of K. Dipal’s deductions, allowed K. Dipal

additional deductions for salaries and wages paid during 2010, and determined

accuracy-related penalties under section 6662(a). Respondent adjusted K. Dipal’s

income using a bank deposits analysis that showed additional receipts of $2,000

for 2009 and $4,160 for 2010 on the basis of additional unreported interest and

dividends K. Dipal received.3

      After the notice was issued, Mr. Shah provided respondent with additional

documents to support a portion of K. Dipal’s claimed deductions disallowed in the

notice of deficiency. On the basis of these documents, respondent sent a letter to

K. Dipal dated July 24, 2012, allowing K. Dipal additional deductions in the

“other expense” category beyond those allowed in the notice of deficiency and

      3
        In its petition K. Dipal stated that it agreed to respondent’s adjustments of
$59 for 2009 and $385 for 2010 for dividends received and a $5 adjustment to
interest income for 2009.
                                       - 15 -

[*15] reflecting a decrease in K. Dipal’s overall deficiency.4 In the July 24, 2012,

letter, respondent asserted the following deficiencies and penalties for K. Dipal:5

                                                                  Penalty
           Year                      Deficiency                 sec. 6662(a)
           2009                       $23,786                      $4,757
           2010                        26,268                        5,254

VI.   Tax Court Proceedings

      Both the Shahs and K. Dipal timely petitioned. The Shahs resided in

Michigan and K. Dipal’s principal place of business was in Michigan at the time

they petitioned. The Court consolidated the cases for trial, briefing, and opinion.

      At trial K. Dipal made two concessions. K. Dipal agreed to respondent’s

determination that it was entitled to deductions for taxes and licenses expenses of

only $4,178 for 2009 and $3,874 for 2010. K. Dipal also agreed to respondent’s

determination that it was entitled to deductions for interest expenses of only

$1,573 and $1,127 for years 2009 and 2010, respectively.


      4
       This letter included a revised Form 4549, Income Tax Examination
Changes, and a revised Form 886-A, Explanations of Items. In addition to taking
into account the supplemental information, the revised forms corrected errors in
how the numbers were presented on the Form 886-A.
      5
        The notice of deficiency dated May 2, 2012, issued to K. Dipal determined
a deficiency of $26,891 and a section 6662(a) penalty of $5,378 for 2009, and a
deficiency of $27,491 and a section 6662(a) penalty of $5,498 for 2010.
                                        - 16 -

[*16] The issues remaining for consideration are whether the Shahs are entitled to

Schedule A, C, and E expense deductions that respondent disallowed; whether K.

Dipal had additional unreported income; whether K. Dipal is entitled to the

business expense deductions that respondent disallowed; and whether the Shahs

and K. Dipal are liable for the accuracy-related penalties that respondent

determined under section 6662(a).

                                      OPINION

      The Shahs, directly and through K. Dipal, deducted personal expenses and

to the extent any of their disallowed expenses may have been deductible, they

failed to substantiate them.

I.    Burden of Proof

      The Commissioner’s determinations in the notice of deficiency are generally

presumed correct, and taxpayers bear the burden of proving otherwise.6 The

burden may shift to the Commissioner under section 7491(a) if the taxpayer has

complied with the necessary substantiation requirements and has maintained all

records and cooperated with reasonable requests by the Commissioner regarding

information and documents. Neither the Shahs nor K. Dipal has adequately

substantiated the expenses in issue. Additionally, neither the Shahs nor K. Dipal

      6
          Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).
                                       - 17 -

[*17] asserts that the burden should shift to respondent. As a result, the burden

remains on the Shahs and K. Dipal.

      In the case of unreported income, before the Commissioner can rely on the

presumption of correctness, he must lay a minimal evidentiary foundation linking

the taxpayer to the income-producing activity.7 Once the Commissioner

sufficiently connects the taxpayer with the unreported income, then the taxpayer

bears the burden of proving that the Commissioner’s determination of unreported

income is wrong.8

      Income tax deductions are a matter of legislative grace, and the taxpayer

bears the burden of proving entitlement to any claimed deduction.9 Further, the

taxpayer is required to maintain sufficient records to “show whether or not such

person is liable for tax”.10




      7
       E.g., United States v. Walton, 909 F.2d 915, 919 (6th Cir. 1990);
Weimerskirch v. Commissioner, 596 F.2d 358, 360 (9th Cir. 1979), rev’g 67 T.C.
672 (1977).
      8
       DiLeo v. Commissioner, 96 T.C. 858, 871 (1991), aff’d, 959 F.2d 16 (2d
Cir. 1992).
      9
       INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992); see also Rule
142(a).
      10
           Sec. 6001.
                                         - 18 -

[*18] II.      Deductions

      The Code allows a deduction for “ordinary and necessary expenses paid or

incurred during the taxable year in carrying on any trade or business”.11 Ordinary

expenses are those transactions that are of “common or frequent occurrence in the

type of business involved.”12 Necessary expenses are “appropriate and helpful” to

the development of the taxpayer’s business.13

      Taxpayers are not allowed deductions for personal, living, or family

expenses except where specifically allowed in the Code.14 And where deductions

are allowable, taxpayers must maintain sufficient records to establish their claimed

deductions, retain these records for as long as the contents may become material,

and keep these records available for inspection.15

      Section 274(d) requires strict substantiation of certain expenses. Such

expenses include those relating to travel, meals and entertainment, gifts, and listed




      11
           Sec. 162(a).
      12
           Deputy v. du Pont, 308 U.S. 488, 495 (1940).
      13
           Welch v. Helvering, 290 U.S. at 113.
      14
           Sec. 262(a).
      15
           Sec. 6001; sec. 1.6001-1(a), (e), Income Tax Regs.
                                       - 19 -

[*19] property under section 280F(d)(4).16 For the years in issue, listed property

included passenger automobiles; any other property used as a means of

transportation; any property of a type generally used for purposes of

entertainment, recreation, or amusement; computers; and cellular telephones.17 To

comply with the strict substantiation rules, the taxpayer must have adequate

records or sufficient evidence corroborating the taxpayer’s own statement to

substantiate the amount of the expense, the time and the place the expense was

paid or incurred, the business purpose of the expense, and the business

relationship of the taxpayer to any others benefited by the expense.18 To

substantiate by adequate records, the taxpayer must maintain an account book, a

log, a diary, or a similar record and documentary evidence to establish each

element of an expenditure.19




      16
           Sec. 274(d).
      17
       Sec. 280F(d)(4) (cellular telephones are not listed property for tax years
beginning after December 31, 2009).
      18
           Sec. 274(d).
      19
       Sec. 1.274-5T(c)(2)(i), Temporary Income Tax Regs., 50 Fed. Reg. 46017
(Nov. 6, 1985).
                                          - 20 -

[*20] Under Cohan v. Commissioner,20 the Court may approximate the amount of

an expense in some instances if the taxpayer can establish a deductible expense

but cannot substantiate the precise amount. However, the taxpayer must provide

some basis for that estimate.21 In addition, the Court is precluded from making

estimates with regard to expenses that are subject to the strict substantiation

requirements under section 274(d).22

III.   Schedule A Unreimbursed Employee Expenses

       We have held that “an individual may be in the trade or business of being an

employee and that ordinary and necessary expenses incurred in that trade or

business are deductible under section 162.”23 However, a deduction is not allowed

if the employee is entitled to reimbursement from his or her employer but does not




       20
            39 F.2d 540, 543-544 (2d Cir. 1930).
       21
            Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985).
       22
      Deely v. Commissioner, 73 T.C. 1081, 1101 (1980); sec. 1.274-5T(a),
Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985).
       23
            Kurkjian v. Commissioner, 65 T.C. 862, 869 (1976).
                                        - 21 -

[*21] request reimbursement.24 And as previously stated, the employee must

substantiate the expense.25

      The Shahs claimed a deduction for unreimbursed employee expenses for

continuing medical education for 2010 on their Schedule A; however, they did not

provide any documents to substantiate these expenses. Further, employees of

Michigan Physicians Group were entitled to reimbursement for reasonable

business expenses, but there is no evidence that Dr. Shah ever sought

reimbursement. Therefore, because the Shahs did not meet their burden, and

because Dr. Shah did not request reimbursement from her employer, the Shahs are

not entitled to this deduction.

IV.   Schedule C Activities

      The Shahs claimed deductions for losses on Schedules C for 2009 and 2010

relating to financial management, IT, and consulting activities of Mr. Shah, and

they are not allowable for two reasons. First, the Shahs failed to substantiate

either that they paid the expenses or the business nature of the expenses. In




      24
     Lucas v. Commissioner, 79 T.C. 1, 7 (1982); see also Orvis v.
Commissioner, 788 F.2d 1406, 1408 (1986), aff’g T.C. Memo. 1984-533.
      25
           Sec. 6001; sec. 1.6001-1(a), Income Tax Regs.
                                        - 22 -

[*22] addition, the claimed expenses are not allowable as deductions because

these activities were not engaged in for profit.

       A.    Lack of Substantiation

       Not only must business expenses be ordinary and necessary, but they also

must be substantiated in order to be deductible. The Shahs failed to substantiate

any of the expenses not allowed as deductions by respondent, and many were

personal and nondeductible.

       The Shahs deducted expenses on Schedules C for: car and truck, travel,

meals and entertainment, business use of home,26 advertising, utilities, interest,

legal and professional services, commissions and fees, supplies, taxes and

licenses, other, and depreciation and section 179. The Shahs grouped all of the

Schedule C expenses together for Mr. Shah’s financial management, IT, and

consulting activities; and with limited exceptions, there was not sufficient

evidence to determine which expense related to a corresponding specific business

activity.

       The car and truck expenses that the Shahs deducted were not strictly

substantiated under section 274(d). To comply with the strict substantiation rules,


       26
        As previously discussed, respondent allowed deductions for the business
use of home expenses for 2009 and 2010 in full.
                                           - 23 -

[*23] the taxpayer must have adequate records or sufficient evidence

corroborating the taxpayer’s own statement to substantiate the amount of the

expense, the time and the place the expense was paid or incurred, the business

purpose of the expense, and the business relationship of the taxpayer to any others

benefited by the expense.27 To substantiate by adequate records, the taxpayer must

maintain an account book, a log, a diary, or a similar record and documentary

evidence to establish each element of an expenditure.28 The Shahs did not

maintain adequate records. The only document they offered to substantiate these

expenses was a noncontemporaneous report that summarized two weeks of

mileage. This evidence is not sufficient substantiation under section 274(d).

Further, the Shahs did not show that these expenses were for business and not

personal use. We agree with respondent’s disallowance of deductions for these

items.

         Similarly, the Shahs did not substantiate their travel expenses. At trial Mr.

Shah stated that the 2009 travel related to a trip to Chicago; however, the Shahs

did not provide any documents to the Court to support these expenses for either




         27
              Sec. 274(d).
         28
              Sec. 1.274-5T(c)(2)(i), Temporary Income Tax Regs., supra.
                                       - 24 -

[*24] year, and they offered no testimony about the 2010 travel. Accordingly, the

Shahs failed to meet their burden of proving that they could deduct these items.

      Additionally, we find that the Shahs are not entitled to deductions for the

meals and entertainment expenses that respondent disallowed. The Shahs testified

that these expenses were for family meals where business was discussed. These

expenses must be strictly substantiated as business expenses, which the Shahs

failed to do. Therefore, the Shahs did not meet their burden of proving that they

could deduct these items.

      For the advertising, other, interest, and depreciation and section 179

expenses, although there was a limited explanation of what these items related to,

the Shahs did not produce any documents such as canceled checks, receipts, credit

card statements, or invoices to substantiate these expenses. Further, there is

insufficient information in the record for us to estimate under Cohan,29 and thus

the Shahs did not meet their burden of proving that they could deduct these

expenses.




      29
        See Lerch v. Commissioner, 877 F.2d 624, 628-629 (7th Cir. 1989)
(finding no duty to estimate under Cohan if taxpayers have no documents to
support their deductions and documents “could easily have been produced”), aff’g
T.C. Memo. 1987-295.
                                        - 25 -

[*25] Finally, the Shahs did not provide any evidence substantiating the utilities,

legal and professional services, commissions and fees, supplies, and taxes and

licenses expenses that they reported. Consequently, they failed to meet their

burden of proving that they could deduct these items.

      B.       Section 183 For-Profit Requirement

      Under section 183(a), in general, taxpayers may deduct only expenses

associated with activities that they engaged in for profit. Taxpayers bear the

burden of establishing that their “endeavor was entered into or conducted with the

intention of making a profit.”30 Profit is defined as “economic profit, independent

of tax savings.”31

      The regulations under section 183 provide nine factors that we use to

determine whether an activity is engaged in for profit.32 The nine factors are: (1)

the manner in which the taxpayer carries on the activity; (2) the expertise of the

taxpayer or the taxpayer’s advisers; (3) the time and effort expended by the

taxpayer in carrying on the activity; (4) the expectation that assets used in the

activity may appreciate in value; (5) the success of the taxpayer in carrying on


      30
           Benz v. Commissioner, 63 T.C. 375, 382 (1974).
      31
           Drobny v. Commissioner, 86 T.C. 1326, 1341 (1986).
      32
           Sec. 1.183-2(b), Income Tax Regs.
                                         - 26 -

[*26] other similar or dissimilar activities; (6) the taxpayer’s history of income or

losses with respect to the activity; (7) the amount of occasional profits, if any, that

are earned; (8) the financial status of the taxpayer; and (9) the elements of personal

pleasure or recreation.33 These nine factors are not an exclusive list, and no one

factor is determinative.34 The Court gives “more weight * * * to objective facts

than to the taxpayer’s mere statement of intent” when it decides whether the

taxpayer intends to make a profit.35

      Our analysis of the for-profit requirement could begin and end with this

single fact: According to Mr. Shah’s own testimony, he neither sought nor

received compensation for any of his Schedule C activities. There was no intent to

make money; rather, his intent for most of these activities was to provide services

to family members and to deduct family expenses. We nonetheless look to the

specific factors.

               1.    Manner in Which Activity Is Conducted

      Under this first factor we focus on whether the taxpayer operated the

activity in a businesslike manner. The Court looks at “whether * * * [the


      33
           Sec. 1.183-2(b), Income Tax Regs.
      34
           Sec. 1.183-2(b), Income Tax Regs.
      35
           Keanini v. Commissioner, 94 T.C. 41, 46 (1990).
                                           - 27 -

[*27] taxpayer] maintained complete and accurate books and records, whether the

activity was conducted in a manner substantially similar to other comparable

businesses which are profitable, and whether changes were attempted in order to

improve profitability.”36 Our finding that the taxpayer did conduct the activity in a

businesslike manner supports an assertion that the activity was engaged in for

profit.

          Here, we find that Mr. Shah did not operate his Schedule C activities in a

businesslike manner. Although Mr. Shah’s testimony that he used Quicken

software to keep track of his expenses reflects some basic business formality, the

Shahs did not substantiate any expenses beyond Mr. Shah’s compiled summary.

Mr. Shah testified that he had created a Web site and a business model to attract

new clients, but after at least 10 years of activity, his only clients were family

members and Michigan Physicians Group. Further, his neither seeking nor

receiving compensation for his services from family members is not consistent

with operating in a businesslike manner. Therefore, this factor weighs against

finding that Mr. Shah intended to make a profit from his Schedule C activities.




          36
               Engdahl v. Commissioner, 72 T.C. 659, 666-667 (1979).
                                         - 28 -

[*28] The Shahs reference Lewenhaupt v. Commissioner37 when they write in

their answering brief: “[A]ll those business activities have been considerable,

regular and continuous, with business plans for all the products / services listed on

my web sites [sic].” Lewenhaupt held that the scope of the activities must be

“considerable, continuous, and regular” for the Court to conclude that the taxpayer

was engaged in a trade or business.38 Lewenhaupt does not help the Shahs

because they offered insufficient proof that Mr. Shah’s Schedule C activities were

considerable, continuous, and regular, such that we would conclude he was

engaged in a trade or business. Despite the fact that Mr. Shah was engaged in the

activities for many years, no evidence establishes that his Schedule C activities

were for profit.




      37
           20 T.C. 151 (1953), aff’d, 221 F.2d 227 (9th Cir. 1955).
      38
           Lewenhaupt v. Commissioner, 20 T.C. at 163.
                                          - 29 -

[*29]            2.    Expertise

        A taxpayer’s studying accepted business, economic, and scientific practices

in the particular field indicates a profit motive.39 The taxpayer’s consulting other

people who are experts in the area points to profit intent as well.40

        Mr. Shah had varying expertise in his Schedule C activities. Mr. Shah had

expertise in the IT and computer consulting field because of his advanced degree

in computer science which complemented his management, database design, data

analysis, and system design activities. The feedback Mr. Shah received from the

doctors at Michigan Physicians Group about what computer software worked best

for patient data entry and recordkeeping also added to his expertise. However, Mr.

Shah had no expertise in financial management or investment consulting. He was

not licensed, nor was there any evidence in the record that he had spent extensive

time studying financial markets, investing, or real estate. On balance, we find that

this factor does not support a finding that his Schedule C activities were for profit.

                 3.    Time and Effort

        Under this factor, the Court looks to see how much time the taxpayer

devotes to the activity and whether it has “substantial personal or recreational


        39
             Sec. 1.183-2(b)(2), Income Tax Regs.
        40
             Sec. 1.183-2(b)(2), Income Tax Regs.
                                        - 30 -

[*30] aspects”.41 Other relevant inquiries are whether the taxpayer withdraws

from another activity to devote more time to the activity in question.42 Finally, if

the taxpayer employs other qualified people to do the work, then the fact that the

taxpayer does not personally devote substantial amounts of time to the activity

does not weigh against our finding a profit motive.43

      The Shahs did not present sufficient evidence to show that Mr. Shah’s time

and effort support finding that his Schedule C activities were for profit.

Specifically, there is nothing in the record that allows us to determine how much

time Mr. Shah spent working in his individual capacity for the IT activities he

reported on his Schedule C. Further, it is unclear from the record how much time

and effort he spent on financial management and consulting. Because of the lack

of evidence, this factor fails to support a conclusion that his Schedule C activities

were for profit.

               4.    Expectation of Asset Appreciation

      A taxpayer’s reasonable expectation that the assets used to further the

activity will appreciate over time can show a profit-making intent despite no


      41
           Sec. 1.183-2(b)(3), Income Tax Regs.
      42
           Sec. 1.183-2(b)(3), Income Tax Regs.
      43
           Sec. 1.183-2(b)(3), Income Tax Regs.
                                          - 31 -

[*31] current year profits.44 However, appreciation projections “based on an

assumption that would have been used by only the most incorrigible optimist”

point to the lack of a profit motive.45

      There is not sufficient evidence on the record to determine what assets Mr.

Shah had that specifically related to his Schedule C activities, nor is there

sufficient evidence to determine whether Mr. Shah expected these assets to

appreciate over time. Accordingly, we cannot conclude that this factor supports a

finding of a for-profit motive.

               5.    Success in Other Activities

      If the taxpayer has previously turned a similar activity around and made it

profitable, then this is another indicator that the taxpayer’s current activity is for

profit even if it is currently generating losses.46

      Mr. Shah was not successful in other activities. Mr. Shah’s Schedule C IT

activities were similar to K. Dipal’s activities, which generated losses. Further, he

was not successful in other activities similar to his Schedule C endeavors because


      44
           Sec. 1.183-2(b)(4), Income Tax Regs.
      45
      Rodriguez v. Commissioner, T.C. Memo. 2013-221, at *44 (citing Swigert
v. Commissioner, T.C. Memo. 1982-500, and Wittstruck v. Commissioner, T.C.
Memo. 1980-62, aff’d, 645 F.2d 618 (8th Cir. 1981)).
      46
           Sec. 1.183-2(b)(5), Income Tax Regs.
                                         - 32 -

[*32] they all had generated losses as well. Therefore, we conclude that this factor

weighs against finding that he was engaged in the Schedule C activities for profit.

               6.    History of Income or Losses

      The regulations provide that “[a] series of years in which net income was

realized would of course be strong evidence that the activity is engaged in for

profit.”47 Similarly, a series of years of net losses would show that the taxpayer

was not engaged in the activity for profit.48 However, if losses are due to

unforeseen circumstances or are within a startup period where losses are

customarily necessary to generate future profitability, this is not a factor that

weighs against finding a for-profit intent.49

      Mr. Shah testified that he had been performing these Schedule C activities

for at least 10 years and has never been paid for them. Indeed, he never sought or

received compensation for them. Therefore, because these activities have a history




      47
           Sec. 1.183-2(b)(6), Income Tax Regs.
      48
        See Wittstruck v. Commissioner, T.C. Memo. 1980-62 (“Continued
retention of the * * * [activity] after any reasonable hope of profit has clearly been
ruled out makes it very difficult for us to find a good faith expectation of profit.”).
      49
           Sec. 1.183-2(b)(6), Income Tax Regs.; Engdahl v. Commissioner, 72 T.C.
at 669.
                                         - 33 -

[*33] of generating losses, this factor weighs against finding that Mr. Shah

intended to earn a profit.

                7.    Amount of Occasional Profits

       Under this factor we compare the amount of profits earned over time in

relation to the amount of losses, investment, and value of the assets.50 If a

taxpayer’s activity generates large losses over a long period, with only an

occasional small profit, this shows that the activity was not engaged in for profit.51

If a taxpayer’s only profits are a “minimal amount”, then “this profit bears little

weight in establishing a primary profit motive.”52 However, substantial occasional

profits with only small losses over time show that the taxpayer intended to make a

profit.53

       As previously stated, for at least 10 years Mr. Shah’s Schedule C activities

have not generated any revenue because he neither sought nor received

compensation for these services. Thus, because there is not a record of any




       50
            Sec. 1.183-2(b)(7), Income Tax Regs.
       51
            Sec. 1.183-2(b)(7), Income Tax Regs.
       52
            Akey v. Commissioner, T.C. Memo. 2014-211, at *17.
       53
            Sec. 1.183-2(b)(7), Income Tax Regs.
                                           - 34 -

[*34] occasional profits from these listed Schedule C activities, we find that this

factor weighs against determining that he engaged in these activities for profit.

      The Shahs mention Sabelis v. Commissioner54 in their answering brief

presumably to show that Mr. Shah’s Schedule C activities were for profit. The

Shahs did not include any analysis in their brief; however, they may have made

reference to Sabelis for its proposition that a taxpayer’s activities can still be for

profit despite not generating net income if there was profit potential. Sabelis does

not help the Shahs. The financial management, IT, and consulting activities were

done as unpaid favors for family members. Mr. Shah testified that he had been

engaged in those activities for more than 10 years and that he neither sought nor

earned compensation. Accordingly, these facts do not show that his Schedule C

activities had profit potential.

               8.    Financial Situation

      If the “taxpayer does not have substantial income or capital from sources

other than an activity [this] may indicate that the activity is engaged in for

profit.”55 Conversely, our finding that the taxpayer has other substantial sources




      54
           37 T.C. 1058 (1962).
      55
           Giles v. Commissioner, T.C. Memo. 2005-28, slip op. at 47.
                                         - 35 -

[*35] of income could weigh against our finding a for-profit activity.56 This is

particularly true if we find that this activity’s losses provide substantial tax

benefits to the taxpayer or if there are personal or recreational aspects to the

activity.57

       We find that the eighth factor weighs against Mr. Shah as well. Dr. Shah

earned income as a physician that the Shahs used to support their family expenses.

Her wages were a substantial source of income for their family whereas Mr.

Shah’s Schedule C activities generated losses that offset Dr. Shah’s income. Thus,

this factor weighs against finding that these activities were for profit.

                9.    Personal Pleasure or Recreation

       The regulations provide that “a profit motiv[e] may be indicated where an

activity lacks any appeal other than profit,” but an “exclusive intention of deriving

a profit” is not required.58

       We cannot conclude that these activities lack any appeal other than profit,

nor can we conclude from the record that Mr. Shah’s intent was to derive a profit.


       56
       Golanty v. Commissioner, 72 T.C. 411, 428-429 (1979), aff’d without
published opinion, 647 F.2d 170 (9th Cir. 1981); sec. 1.183-2(b)(8), Income Tax
Regs.
       57
            Sec. 1.183-2(b)(8), Income Tax Regs.
       58
            Sec. 1.183-2(b)(9), Income Tax Regs.
                                         - 36 -

[*36] Although these activities are not typically the kind of activities that would

reasonably be said to be predominantly for personal pleasure or recreation, there is

insufficient evidence to make a conclusive determination. Therefore, we cannot

conclude that this factor supports a finding of a for-profit intent.

      Overall, we conclude that Mr. Shah’s Schedule C activities were not for

profit because they do not satisfy the for-profit requirements under section 1.183-

2(b), Income Tax Regs. Unless otherwise allowable, any expenses associated with

these activities would be deductible only to the extent of gross income generated

from those activities. Because these activities did not generate income and the

expenses are not otherwise allowable, section 183 bars deductions for the related

expenses.59

      Although it appears that a portion of the expenses associated with the IT

activity may have been related to K. Dipal, neither the Shahs, K. Dipal, nor

respondent argued for reallocating any expenses from the Shahs’ Schedule C to K.

Dipal. Accordingly, we do not reach this issue. And even if they had argued

reallocation was appropriate, because of insufficient evidence we are not able to

identify which of the Schedule C expenses are attributable to the IT activities. The




      59
           See sec. 183(b).
                                        - 37 -

[*37] Shahs’ returns do not separate the expenses on Schedule C between Mr.

Shah’s IT, financial management, and consulting activities.

V.    Rental Property

      For the years in issue the Shahs’ Woodward Avenue property generated

rental income, and respondent disallowed portions of the Shahs’ reported rental

expense deductions. Respondent showed that the $12,000 of income reported on

Schedule C for 2009 was rental income from the Woodward Avenue property and

argued that the income and expenses associated with the Shahs’ Woodward

Avenue property should have been reported on Schedule E. For 2010 respondent

eliminated $9,600 of rental income from Schedule C because it was reported on

both Schedules C and E. During both years respondent disallowed deductions for

many of the expenses that Mr. Shah reported but allowed deductions for repairs,

taxes, depreciation, and insurance expenses in its notice of deficiency.

      Section 469 prevents taxpayers from reducing nonpassive income by losses

attributable to passive activities.60 Rental activities are generally considered to be

passive activities under section 469(c)(2).




      60
     Hillman v. Commissioner, 118 T.C. 323, 329 (2002); Langille v.
Commissioner, T.C. Memo. 2010-49, aff’d, 447 Fed. Appx. 130 (11th Cir. 2011).
                                         - 38 -

[*38] “There are two principal exceptions to the general rule that rental real estate

activities are per se passive activities.”61 The first exception is for taxpayers who

qualify as real estate professionals,62 and the other exception applies if a person

actively participates in the activity during the year.63

      The Shahs leased their Woodward Avenue property for income. This is a

passive activity unless they show that they are either real estate professionals or

actively participating. They did not present any evidence that they meet either

criterion. Because the rental of the Woodward Avenue property is unrelated to the

Schedule C activities, it is not appropriate to aggregate the rental activity on

Schedules C as the Shahs did. Although they argued in their petition that their

rental activities for the Woodward Avenue property did not begin until 2010, Mr.

Shah testified at trial that the $12,000 in income for 2009 on Schedule C was from

the Woodward Avenue property. Consequently, the rental income and expenses

attributable to the Woodward Avenue property belong on Schedules E.64 Further,



      61
           Moss v. Commissioner, 135 T.C. 365, 368 (2010).
      62
           Sec. 469(c)(7).
      63
           Sec. 469(i)(1).
      64
        See 2009 Instructions for Schedule E (Form 1040), E-1; 2010 Instructions
for Schedule E (Form 1040), E-1.
                                        - 39 -

[*39] because the Shahs have not presented any documents to substantiate the

expenses they claimed for this property, we sustain respondent’s determination

disallowing deductions for most of these expenses.

VI.   Unreported Income for K. Dipal

      Where a taxpayer fails to keep sufficient records under section 6001, the

Commissioner may compute taxable income through a method that clearly reflects

income. The Commissioner’s use of the bank deposits analysis method has long

been approved in such an instance.65 This method “assumes that all money

deposited in a taxpayer’s bank account during a given period constitutes taxable

income, but the Government must take into account any nontaxable source or

deductible expense of which it has knowledge.”66 Nontaxable sources include

funds attributable to “‘loans, gifts, inheritances, or assets on hand at the beginning

of the taxable period.’”67




      65
           Nicholas v. Commissioner, 70 T.C. 1057, 1064 (1978).
      66
     Clayton v. Commissioner, 102 T.C. 632, 645-646 (1994) (citing DiLeo v.
Commissioner, 96 T.C. at 868).
      67
      Burgo v. Commissioner, 69 T.C. 729, 743 n.14 (1978) (quoting Troncelliti
v. Commissioner, T.C. Memo. 1971-72).
                                        - 40 -

[*40] A bank deposits analysis may provide prima facie evidence of income, and

the Commissioner is not required to prove the likely source of the income.68 The

taxpayer bears the burden of establishing that items should be excluded from

income or allowed as deductions.69 One way of proving that an item should have

been excluded would be to show that the deposit is derived from a nontaxable

source.70

      Respondent determined $2,000 of unreported income for 2009 and $4,160

for 2010 for K. Dipal on the basis of his bank deposits analysis. In its petition K.

Dipal disagreed with these additions, claiming these amounts were nontaxable

reimbursements for Web site development, but it did not provide any evidence at

trial to substantiate this claim. As a result, K. Dipal did not meet its burden of

proving that these amounts should not have been included in its taxable income.

VII. K. Dipal’s Expenses

      K. Dipal claimed deductions for the following expenses: taxes and licenses,

interest, salaries and wages, repairs and maintenance, advertising, pension and

profit sharing, and other expenses. These “other expenses” were further itemized


      68
           Tokarski v. Commissioner, 87 T.C. 74, 77 (1986).
      69
           Gemma v. Commissioner, 46 T.C. 821, 833 (1966).
      70
           See Nicholas v. Commissioner, 70 T.C. at 1064.
                                           - 41 -

[*41] into the following categories: training and education, legal and professional

services, utilities, accounting, auto and truck, bank charges, dues and

subscriptions, insurance, laundry and cleaning, outside services and independent

contractors, parking fees and tolls, postage, supplies, telephone, and travel.

        Both parties made concessions relating to K. Dipal’s claimed deductions.

At trial K. Dipal agreed to respondent’s determinations of taxes and licenses

expense deductions of only $4,178 for 2009 and $3,874 for 2010 and interest

expense deductions of only $1,573 for 2009 and $1,127 for 2010. Respondent in

his letter to K. Dipal dated July 24, 2012, allowed additional deductions beyond

what K. Dipal claimed for salaries and wages.

        K. Dipal did not produce any documents to substantiate the repairs and

maintenance, advertising, or pension and profit-sharing expenses that it

deducted.71 Although Mr. Shah presented a yearend brokerage statement from

2011 that purported to substantiate the pension and profit-sharing expense, it was

not admitted as evidence at trial because it did not shed light on when

contributions were made. Further, the brokerage statements K. Dipal attached to




        71
             K. Dipal deducted $9,000 for pension and profit-sharing contributions for
2010.
                                       - 42 -

[*42] its petition are not part of the record before us. Accordingly, we sustain

respondent’s disallowance of deductions for these expenses.

      Of the “other expenses” deductions claimed, K. Dipal provided a Quicken

summary that purported to show all of its cashflows for the years in issue, and Mr.

Shah testified about these expenses. Many of the expenses K. Dipal reported were

personal to the Shahs and not deductible because the expenses are not typical

expenses for an IT business and do not satisfy the “ordinary and necessary”

requirement of section 162. Specifically, the lawn mowing expenses were for

lawn care at the Shahs’ personal residence. The education expenses were for their

daughter’s private high school tuition. The medical expenses were for vitamins,

doctors’ bills, and prescriptions for Mr. Shah. The miscellaneous household and

home repair expenses in 2010 were for the Shahs’ entire home and not just for the

880 square feet respondent allowed as a home office. K. Dipal provided no

evidence connecting these expenses with the home office. The retail purchases

were for Mr. Shah’s professional attire and clothing for his family. The utilities

expenses related to their personal residence. The gifts were given to his family

members.

      Most of the amounts and categories listed on this Quicken summary

provided at trial did not match the amounts and categories that K. Dipal reported
                                        - 43 -

[*43] on its Forms 1120 when it itemized the “other expenses”. Further, K. Dipal

did not provide any documents, such as receipts, credit card statements, bank

account statements, or canceled checks, to substantiate these expenses on the

Quicken summary.

      Respondent allowed $12,862 of the $98,107 in “other expenses” deductions

K. Dipal claimed for 2009 and $8,411 of the $76,291 in “other expenses”

deductions for 2010 on the basis of documents K. Dipal provided during the audit.

Other than uncorroborated testimony and the Quicken summary, K. Dipal did not

substantiate these expenses. K. Dipal argues in its answering brief that because

Mr. Shah used Quicken software to keep track of K. Dipal’s expenses and because

Mr. Shah never entered an expense into Quicken without supporting bank

information, it has sufficiently substantiated these expenses. We do not agree.

The Quicken summary was not contemporaneous and not supported by source

documents and the amounts did not match most of the amounts and categories

itemized on K. Dipal’s returns. Further, most of the expenses appear to be

personal. Accordingly, we do not allow any additional deductions beyond those

that respondent allowed in his July 24, 2012, letter.
                                         - 44 -

[*44] VIII. Section 6662(a) Accuracy-Related Penalties

      Section 6662(a) and (b)(1) and (2) imposes a 20% accuracy-related penalty

on any portion of an underpayment of tax required to be shown on a return if the

underpayment is due to, among other reasons, negligence, disregard of rules or

regulations, or any substantial understatement of income tax. Respondent bears

the burden of production as to the Shahs’ penalties.72 The penalties will not apply

to any portion of the underpayment for which a taxpayer establishes that he or she

had reasonable cause and acted in good faith.73

      As defined in the Code, “‘negligence’ includes any failure to make a

reasonable attempt to comply with the provisions of this title, and the term

‘disregard’ includes any careless, reckless, or intentional disregard.”74 Negligence

has been further defined as a “‘lack of due care or failure to do what a reasonable

and ordinarily prudent person would do under the circumstances.’”75 Additionally,


      72
        See sec. 7491(c). We note that respondent does not bear the burden of
production as to penalties of K. Dipal (a corporation) because section 7491(c)
refers only to an “individual”. NT, Inc. v. Commissioner, 126 T.C. 191, 195
(2006).
      73
           Sec. 6664(c)(1).
      74
           Sec. 6662(c).
      75
           See Neely v. Commissioner, 85 T.C. 934, 947 (1985) (quoting Marcello v.
                                                                      (continued...)
                                         - 45 -

[*45] a taxpayer is negligent if he fails to maintain sufficient records to

substantiate the items in question.76

      An understatement of income tax is “substantial” if the understatement

exceeds the greater of 10% of the tax required to be shown on the return or

$5,000.77 However, if the taxpayer has substantial authority for the tax treatment

of an item, then the portion of the tax attributable to that item is not included in the

understatement.78 A taxpayer has substantial authority only if the weight of

authority supporting the tax treatment of the item outweighs the contrary

authority.79

      After taking into account the parties’ concessions, the Shahs’ 2010

understatement and K. Dipal’s understatements for both 2009 and 2010 exceed

      75
        (...continued)
Commissioner, 380 F.2d 499, 506 (5th Cir. 1967), aff’g in part, remanding in part
43 T.C. 168 (1964)); sec. 1.6662-3(b)(1)(ii), Income Tax Regs. (“Negligence is
strongly indicated where * * * [a] taxpayer fails to make a reasonable attempt to
ascertain the correctness of a deduction, credit or exclusion on a return which
would seem to a reasonable and prudent person to be ‘too good to be true’ under
the circumstances[.]”).
      76
       Higbee v. Commissioner, 116 T.C. 438, 449 (2001); sec. 1.6662-3(b)(1),
Income Tax Regs.
      77
           Sec. 6662(d)(1)(A).
      78
           Sec. 1.6662-4(d)(1), Income Tax Regs.
      79
           Sec. 1.6662-4(d)(3)(i), Income Tax Regs.
                                       - 46 -

[*46] 10% of the tax required to be shown on the respective returns and are greater

than $5,000. Accordingly, the substantial understatement penalties under section

6662(b)(2) apply.

      Respondent has not met his burden of production for applying the

substantial understatement penalty against the Shahs for 2009 because there is not

a substantial understatement of income tax for this year. The Shahs reported a

total tax of $57,198. We agree with respondent’s determination that the amount of

tax required to be shown on the Shahs’ return is $63,300. Thus, the Shahs

understated their tax by $6,102, which is less than 10% of the tax required to be

shown on the return. Accordingly, respondent has not shown that there is a

substantial understatement of income tax for 2009.

      However, respondent has shown that the Shahs and K. Dipal acted with

negligence. Neither the Shahs nor K. Dipal introduced sufficient records to

substantiate the expenses they reported. The Shahs and K. Dipal lacked a

reasonable basis for deducting those expenses because they were personal,

including things like lawn care and private school tuition expenses.

      Further, because they lacked a reasonable basis for deducting these

expenses, it follows that they lacked substantial authority for these claimed
                                        - 47 -

[*47] deductions. Thus, the Shahs and K. Dipal did not meet the substantial

authority standard for overcoming the substantial understatement penalty.

      The Shahs and K. Dipal argued that the section 6662(a) penalties should not

apply because Mr. Shah’s using tax preparation software to generate the returns

shows that they acted with reasonable cause and in good faith under section

6664(c)(1). Tax preparation software users must enter accurate information for

the software to prepare correct returns. Mr. Shah entered personal items into the

tax preparation software as business expenses. Therefore, he caused the software

to generate erroneous returns.80 Accordingly, we find that neither the Shahs nor K.

Dipal satisfies the reasonable cause and good-faith defense of section 6664(c).

IX.   Conclusion

      The Shahs and K. Dipal deducted many personal expenses for 2009 and

2010 as business expenses. K. Dipal also omitted some income. Because most of

the deducted expenses were personal, without substantiation, or a combination of

both, we sustain respondent’s determinations in the notice of deficiency as to the

Shahs and in the notice of deficiency as revised by the letter dated July 24, 2012,

for K. Dipal. Further, we hold that both the Shahs and K. Dipal are liable for the

accuracy-related penalties under section 6662(a) for 2009 and 2010.

      80
           In the IT profession, this is known by the acronym “GIGO”.
                                       - 48 -

[*48] We have considered the parties’ arguments and, to the extent not addressed

here, we find them to be irrelevant, moot, or without merit.

      To reflect the foregoing,


                                                Appropriate decisions will be entered

                                       for respondent.
