                  T.C. Summary Opinion 2004-82



                     UNITED STATES TAX COURT



                  LUIS ACLE, JR., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 20069-02S.              Filed June 23, 2004.


     Luis Acle, Jr., pro se.

     Donna L. Pahl, for respondent.



     GOLDBERG, Special Trial Judge:   This case was heard pursuant

to the provisions of section 7463 of the Internal Revenue Code in

effect at the time the petition was filed.   The decision to be

entered is not reviewable by any other court, and this opinion

should not be cited as authority.   Unless otherwise indicated,

subsequent section references are to the Internal Revenue Code in

effect for the year in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure.
                               - 2 -

     Respondent determined a deficiency in petitioner’s Federal

income tax of $40,818, and an accuracy-related penalty of

$7,683.20, for the taxable year 1998.

     The issues for decision are:   (1) With respect to

petitioner’s rental activities, whether the losses petitioner

incurred are subject to the passive activity loss limitations of

section 469; (2) with respect to petitioner’s business

activities, (a) whether petitioner received unreported income as

determined by respondent, and (b) whether petitioner is entitled

to a business expense deduction disallowed by respondent; and (3)

whether petitioner is liable for the accuracy-related penalty

under section 6662(a).   The adjustments in the notice of

deficiency to the itemized deductions and to the self-employment

income tax and the deduction therefor are computational and will

be resolved by the Court’s holding on the issues.

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

The stipulation of facts and the attached exhibits are

incorporated herein by this reference.   Petitioner resided in San

Diego, California, on the date the petition was filed in this

case.

     Petitioner filed a Federal income tax return for taxable

year 1998 with the filing status of head of household.

Petitioner reported $300 of interest income, a $6,760 business

loss, and a $62,297 loss from rental activities, for an adjusted
                                        - 3 -

gross income of negative $68,757.               Petitioner also claimed

dependency exemption deductions for two daughters and itemized

deductions of $25,288 for mortgage interest and real estate

taxes, resulting in a taxable income of negative $102,145, and

zero tax liability.

1.   Petitioner’s Rental Activities

     During 1998, petitioner owned or held partial ownership

interests in seven separate rental properties.                  Petitioner is not

a real estate professional, and he did not personally manage any

of the rental properties.            Three of the properties are in the San

Diego area and during 1998 were professionally managed by Westman

Property Management.        The other four properties are located in

the Washington, D.C., area and during 1998 were professionally

managed by Yarmouth Property Management.                On his Federal income

tax return, petitioner reported the following income and expenses

with respect to the rental properties, reporting an overall

deductible loss of $62,297:
                     California Properties        Washington, D.C., Area Properties

                     San      San      Spring    Arlington   Wash.    Wash.     Wash.
                    Diego    Diego     Valley    Virginia    D.C.     D.C.      D.C.

 Rents received     $9,950 $11,160 $104,488  $13,620 $36,016     $26,365   $48,962
 Less cash expenses 9,871    8,490   88,781   17,832   38,530     37,786    56,630
 Less depreciation     467   1,167   19,089    7,999    8,145      8,399     9,672
 Gain (loss)         ($388) $1,503 ($3,382) ($12,211) ($10,659) ($19,820) ($17,340)

Petitioner did not directly receive the rents from these

properties.    Instead, the rental management companies collected

the rents, paid the related expenses, and then billed petitioner
                                  - 4 -

for the expenses which were in excess of the total amount of rent

collected, if necessary.

     In the notice of deficiency, respondent disallowed $59,918 of

the losses claimed by petitioner with respect to the rental

properties.    Although petitioner disputes the disallowance of the

losses, he has made no arguments with respect to this issue, and

at trial he stated that this issue “seems to be a matter of law”.

     Section 469 imposes limits on deductions for losses from any

passive activity.    Under section 469(a)(1), an individual may not

deduct a passive activity loss, which is defined in section

469(d)(1) to be the excess of the individual’s aggregate losses

from passive activities over his aggregate income from passive

activities.    As a general rule, any rental activity is a passive

activity.    Sec. 469(c)(2).    A rental activity in turn is “any

activity where payments are principally for the use of tangible

property”.    Sec. 469(j)(8).    Although certain exceptions apply to

this general rule, petitioner does not assert, and the record does

not show, that any such exceptions apply in this case.      Thus,

petitioner’s rental activities with respect to the seven

properties are passive activities, and petitioner is not allowed a

deduction for his aggregate losses with respect thereto.      Sec.

469(a)(1).    Respondent disallowed $59,918 of the claimed deduction

of $62,297 with respect to petitioner’s rental activities; it is

not clear from the record why respondent determined that a portion
                                - 5 -

of the loss was allowable.   Respondent has not sought to disallow

the remaining $2,379 of the loss, and we therefore do not address

respondent’s calculation of the allowable amount of the loss.

2.   Petitioner’s Business Activities

     During the year in issue, petitioner was engaged in certain

business consulting activities.   In connection with these

consulting activities, petitioner served as the chief executive

officer of an entity named North American Free Trade Association

(NAFTA), which is incorporated in Mexico.    In this position,

petitioner would provide services to foreign companies seeking to

do business in Mexico.   Petitioner would allow his clients, the

foreign companies, to use the address of NAFTA’s office in Mexico

City.   NAFTA maintained a bank account in Mexico.

     Petitioner also operated a business activity under the name

of Occidental Utilities (OU).   While petitioner entered into at

least one agreement with a client in which petitioner asserted

that OU was a Delaware corporation, petitioner does not recall

incorporating OU, and in any event petitioner conducted business

only as a sole proprietor under that name.    In this business

activity, petitioner provided consulting services within the

utilities industry.    In 1996 or 1997, petitioner entered into a

contract with a business known as San Luis Tank to provide

consulting services.   In connection with this agreement, San Luis

Tank issued petitioner a Form 1099-MISC, Miscellaneous Income,
                               - 6 -

reflecting a payment of $12,000 to petitioner in 1998.

Petitioner’s relationship with San Luis Tank lasted until that

business ceased operations in 2000.

     Also during 1996 or 1997, petitioner entered into a contract

with PSEG Global, Inc., to provide consulting services.    PSEG

Global was interested in building and operating a power plant in

San Luis, Mexico.   During 1998, petitioner assisted PSEG Global by

performing various tasks including negotiating with the Mexican

government, acting as a conduit in obtaining the proper

certifications and permits that are required in Mexico, and

engaging in other business negotiations.    Petitioner prepared

monthly billing invoices for the work he performed for PSEG

Global.   These invoices indicate that they are from “Luis Acle,

Occidental Utilities”, and the total amount billed by petitioner

in 1998 was $160,310.   Of this amount, $140,763 was for services

petitioner rendered and $19,548 was for expenses he incurred.      On

certain occasions, PSEG Global would refuse payment of certain

charges or modify the amount requested.    PSEG Global’s records

indicate the addition of three payments other than those shown on

petitioner’s invoices, totaling $11,679, and the omission of one

payment of $12,360 that was requested by petitioner on an invoice.

The one payment that petitioner requested but which is not shown

on PSEG Global’s records as having been paid is a request for fees

of $10,000 and expenses of $2,360, on an invoice dated November
                                - 7 -

25, 1998.   Although PSEG Global’s records reflect payments to

petitioner in 1998 totaling $159,629, PSEG Global issued

petitioner a Form 1099-MISC on which it reported payments to

petitioner totaling $168,598 during that year.   Petitioner ceased

working on behalf of PSEG Global in 1999.

     During 1998, petitioner maintained at least two bank accounts

in the United States.   The first was maintained under the name of

OU at Wells Fargo Bank, and the second was maintained under the

names of petitioner and M. Cristina A Robles at Home Savings of

America.    Amounts totaling $269,767 were deposited into the first

account, and $55,389 was deposited into the second account.1

     Petitioner filed a Schedule C, Profit or Loss From Business,

with his Federal income tax return for taxable year 1998.   This

schedule named petitioner as the proprietor of a business engaged

in “international business consulting”.     The schedule listed the

name of the business as “NAFTA”, and it provided an address in

Mexico City.   Neither party addressed the use of petitioner’s

corporation’s name on the Schedule C.   Based on petitioner’s

testimony and other evidence in the record, we conclude that the



     1
      The total deposit amounts are those reflected in the bank
deposit summaries prepared by respondent. Respondent calculated
the amount of the deposits using the account statements provided
by petitioner. Several of these statements were not available,
leaving gaps of approximately 2 weeks with respect to Wells Fargo
Bank and approximately 6 weeks with respect to Home Savings of
America. Respondent based his determination solely on the time
periods for which bank statements were available.
                                - 8 -

Schedule C was filed for OU rather than for NAFTA.    Petitioner

reported Schedule C gross receipts of $116,280 and claimed

deductions totaling $123,040 for various expenses, for an overall

loss of $6,760.   One of the expenses claimed as a deduction by

petitioner is in the amount of $17,000 and is described as

“administrative Mexico”.

     In the notice of deficiency, respondent determined that

petitioner received $144,102 in unreported income from his

business activities.   Respondent calculated this amount as

follows:

     Bank deposits                                $325,155
     Less transfers between accounts                26,095
     Less line of credit advances                   38,678
     Less gross receipts reported on return        116,280
     Unreported income                            $144,102

Respondent now concedes that the amount of unreported income

should be reduced by $7,745 to $136,357 to reflect credit card

overdraft transfers into petitioner’s accounts.   Respondent also

disallowed in the notice of deficiency the $17,000 deduction

claimed by petitioner as “administrative Mexico”.    Respondent

allowed the deductions for each of the other expenses claimed by

petitioner on the Schedule C.
                                - 9 -

     A.   Unreported Income

     Gross income generally includes “income from whatever source

derived”, unless specifically excluded by statute.    Sec. 61(a).

Taxpayers are required to maintain records sufficient to establish

the amounts of income, deductions, and other items which underlie

their Federal income tax liabilities.    Sec. 6001; sec. 1.6001-

1(a), (e), Income Tax Regs.    If a taxpayer fails to keep adequate

books and records, the Commissioner may reconstruct the taxpayer’s

income by any method that is reasonable under the circumstances.

Petzoldt v. Commissioner, 92 T.C. 661, 687 (1989); see also United

States v. Fior D’Italia, Inc., 536 U.S. 238, 243 (2002) (stating

that the assessment authority of the IRS is not exceeded “when the

IRS estimates an individual’s tax liability--so long as the method

used to make the estimate is a ‘reasonable’ one”).    The

reconstruction need not be exact, so long as it is reasonable and

substantially correct.   Petzoldt v. Commissioner, supra at 693;

Meneguzzo v. Commissioner, 43 T.C. 824 (1965).    The use of bank

deposits is recognized as a reasonable method of reconstructing

income.   Parks v. Commissioner, 94 T.C. 654, 658 (1990); Tokarski

v. Commissioner, 87 T.C. 74, 77 (1986); Nicholas v. Commissioner,

70 T.C. 1057, 1065 (1978).    This method is premised on the

assumption that the deposits into a taxpayer’s account consist of

income from taxable sources.    See sec. 61(a).
                                - 10 -

     As a general rule, a taxpayer bears the burden of proving the

Commissioner’s determinations in a notice of deficiency to be in

error.   Rule 142(a).2   Certain courts have recognized a limited

exception to the general rule where the notice of deficiency

determines that the taxpayer failed to report income.     Llorente v.

Commissioner, 649 F.2d 152, 156 (2d Cir. 1981), affg. in part and

revg. in part 74 T.C. 260 (1980); Weimerskirch v. Commissioner,

596 F.2d 358 (9th Cir. 1979), revg. 67 T.C. 672 (1977).    In such

circumstances, the Commissioner must come forward with evidence

establishing a minimal foundation, which may consist of evidence

linking the taxpayer with an income-producing activity.    Petzoldt

v. Commissioner, supra at 689.    In the present case, petitioner

does not dispute that he received income with respect to the

relevant business activities.

     Petitioner argues that respondent’s determination concerning

the receipt of unreported income is in error.    To this effect,

petitioner argues that he

     received a certain amount of money as compensation for my
     services. I acknowledged that, and that was reported. There
     are additional amounts that were third party expenses that
     had nothing to do with me for which I was nonetheless
     responsible. There were a number of deposits that were made
     from one account to another, primarily because the expenses,


     2
      Sec. 7491(a), which shifts the burden of proof to the
Commissioner under certain circumstances, does not apply with
respect to any factual dispute in this case because petitioner
did not keep adequate books and records and did not meet
statutory substantiation requirements. Sec. 7491(a)(2)(A) and
(B).
                              - 11 -

     including the real estate expenses, were coming out of those
     accounts.
          Therefore * * * my contention is that a number of these
     additional amounts that are presumed by the IRS to be income
     are simply transfers from one account to another or deposits
     that were made after money was taken from that same account.
     Therefore, a lot of money was counted two or three times.
          In addition, * * * I would suggest that there are a
     number of expenses, including all of those for St. Luis Tank,
     that were expenses channeled through me and going to other
     people, including specifically people who were providing
     services to that company, without it being any income to me
     or expendable, nor was it claimed as an expense fund.

Thus, petitioner argues that a portion of the deposits consists of

reimbursements for expenses petitioner incurred on behalf of

clients, and that a portion of the deposits consists of transfers

between accounts or amounts that were withdrawn and redeposited

into the same account.   Petitioner does not provide details

concerning specific amounts of either the alleged reimbursements

or the alleged transfers.

     In certain cases, reimbursements received by a taxpayer

engaged in a trade or business for expenses incurred on behalf of

another are not included in the taxpayer’s gross income.     Gray v.

Commissioner, 10 T.C. 590 (1948).   However, in the absence of

adequate records and proper substantiation, it remains the

taxpayer’s burden to show error in the Commissioner’s

determination that bank deposits are income.   Sec. 7491(a); Rule

142(a); Tokarski v. Commissioner, supra at 76-77.

     The only corroborating evidence in the record showing that

petitioner received reimbursements from his clients lies in the
                              - 12 -

invoices that petitioner submitted to PSEG Global on which he

requested reimbursement for expenses totaling $19,548.   PSEG

Global’s records indicate that the company paid all but $2,360 of

these expenses in accordance with petitioner’s requests for

payment.   Petitioner, however, claimed deductions for numerous

expenses on his Schedule C, in an amount totaling $123,040.

Respondent has not challenged $106,040 of these deductions, some

of which are for expenses that are of the same type as those for

which petitioner requested reimbursement from PSEG Global.

Because petitioner’s Schedule C was filed for his consulting

business, and PSEG Global was the primary source of income for

this business, we conclude that the Schedule C deductions

substantially encompass the expenses for which petitioner was

reimbursed by PSEG Global.   A taxpayer is not entitled to both

exclude an amount from income as a reimbursement of an expense and

then deduct the same amount as a business expense.   See generally

sec. 1.161-1, Income Tax Regs. (providing that “Double deductions

are not permitted”.).   Because petitioner has failed to provide

records of any sort supporting the amount of his deductions, the

Court cannot ascertain whether the $17,188 in reimbursements

petitioner received is wholly reflected in the $106,040 of allowed

expenses that he claimed as deductions on his return.    We conclude

that petitioner has failed to show either that he is entitled to

exclude from income any portion of the reimbursements he received
                               - 13 -

from PSEG Global, or that he is entitled to additional deductions

with respect to the underlying expenses.    See Rule 142(a).

     Petitioner further argues that he received reimbursements

from other sources, such as San Luis Tank.    However, petitioner

has presented no credible evidence that any of the amounts

deposited into his bank accounts were reimbursements for expenses

incurred on behalf of San Luis Tank or any other entity or

individual.    The only evidence to this effect was petitioner’s own

self-serving, uncorroborated testimony, which we do not find to be

credible:   At more than one point in his testimony, petitioner

stated that he could not recall the purpose of individual

withdrawals or deposits noted on his bank account statements.

     Petitioner’s next argument is that a portion of the deposits

into his accounts consists of transfers between accounts or

amounts that were withdrawn and subsequently redeposited into the

same account.   The only evidence in the record pertaining to this

argument lies in bank statements from the bank accounts at Wells

Fargo Bank and Home Savings of America, and copies of checks drawn

on the Wells Fargo account.    While petitioner was unable to

discuss the bank statements in detail, certain of the Wells Fargo

checks clearly indicate that they were for transfers to another

account.    However, the total amount of these checks is less than

the amount already taken into account as transfers in respondent’s

calculation.    Other Wells Fargo checks were written to Household
                               - 14 -

Bank; these checks represent mortgage payments by petitioner.

Most of the remaining checks were written to petitioner himself or

to Wells Fargo, presumably indicating that on some occasions

petitioner was withdrawing cash from his account.   There is no

evidence that any such withdrawal was redeposited into

petitioner’s account.   To the contrary, there is evidence that at

least a portion of such funds was used to make payments on a line

of credit or another loan.   In summary, we find that the Wells

Fargo checks do not refute any aspect of respondent’s calculation

of petitioner’s unreported income.

     Other than the two general arguments discussed above,

petitioner has not presented any specific objections to

respondent’s reconstruction of petitioner’s income.   For example,

petitioner has not argued that any individual deposit is from a

nontaxable source, nor has petitioner asserted, or provided

evidence tending to show, that any deposit was from an alternative

source, such as a savings account.

     Finally, petitioner summarizes his argument that respondent’s

determinations are in error by stating:

     I think that there is clear evidence of the fact that there
     is a certain amount of necessary recycling of this money for
     the reasons that I have explained to the points that there’s
     no way that anybody could say that this clearly reflects
     income.

We disagree with petitioner.   While respondent’s reconstruction of

petitioner’s records certainly is not exact, we find the
                               - 15 -

reconstruction to be substantially correct and to be a more

accurate reflection of petitioner’s income than what was reported

on his return.   See Petzoldt v. Commissioner, 92 T.C. at 687;

Meneguzzo v. Commissioner, 43 T.C. 824 (1965).   Although the

amount of income exceeds that which was reported on the two Forms

1099-MISC appearing in the record, at least one of the forms has

been shown to be inaccurate.   Furthermore, the forms were issued

by only two sources; it is reasonable to conclude that petitioner

had other income generated from his business activities during

1998, either directly from his operation of OU or indirectly

through his corporation, NAFTA.   There is no evidence in the

record establishing the amount of income that petitioner derived

from NAFTA.   Finally, according to the information reported by

petitioner on his 1998 return, petitioner had a negative taxable

income of $102,145.   Petitioner has not explained how he would

have been able to pay the disproportionately large amount of

expenses shown on his return in comparison to the gross income

that he reported, while at the same time maintaining a standard of

living for himself and for his two daughters, whom he claimed as

dependents.

     We sustain respondent’s determination concerning petitioner’s

unreported income, as adjusted for respondent’s concession that
                               - 16 -

petitioner had $7,745 less unreported income than the amount

determined in the notice of deficiency.3

     B.   Business Expense

     Petitioner argues that respondent’s disallowance of the

$17,000 Schedule C deduction for “administrative Mexico” is in

error.    Petitioner stated at trial that the $17,000 represents the

“cost of doing business” in Mexico City.   In particular,

petitioner asserts that he lost office equipment valued at “a

little over $10,000” in a burglary, and that he was forced to

scrap an automobile--because “the oil pump or something had gone

bad and the car was basically ruined”--for which he “took a little

over a $7,000 loss”.

     It is unclear from the record whether the office to which

petitioner refers in his testimony regarding this issue was the

office of NAFTA, petitioner’s Mexico City-based corporation.    A

corporation formed for legitimate business purposes is an entity


     3
      We briefly address a factual issue that was not discussed
by either party--the interrelationship between the rental
activity issue and the unreported income issue. In light of
petitioner’s burden of proof in this regard, see Rule 142(a), we
note that the record does not support a finding that any of the
amounts deposited into petitioner’s bank accounts were derived
from the rental activities. We reach this conclusion based upon
the record as a whole, which establishes, inter alia, that the
property management companies rather than petitioner collected
the rents and paid the expenses therefrom; that petitioner held
only partial ownership interests in several of the properties;
that petitioner may have held bank accounts other than the two
named above; and that no deposits listed in the bank statements
have been identified as having been derived from the rental
properties.
                                - 17 -

separate from its shareholders, and the business of the

corporation is separate and distinct from the business of its

shareholders.     Moline Props., Inc. v. Commissioner, 319 U.S. 436,

438-439 (1943); Deputy v. du Pont, 308 U.S. 488, 494 (1940).

Thus, a shareholder generally is not entitled to a deduction for

the payment of corporate expenses, Deputy v. du Pont, supra;

Hewett v. Commissioner, 47 T.C. 483 (1967), and petitioner

accordingly would not be entitled to deduct NAFTA’s expenses.

     We assume arguendo that petitioner is asserting that the

$17,000 expense was incurred in connection with OU rather than

NAFTA.   Nevertheless, petitioner provided only vague,

uncorroborated testimony to substantiate the $17,000 expense at

issue, and we do not find petitioner’s testimony concerning this

issue to be reliable.     Furthermore, we note that petitioner’s

description of the expense at trial does not appear to be

consistent with the description of the expense given on the

Schedule C.     We conclude that petitioner has failed to

substantiate the disallowed deduction.      See sec. 6001; sec.

1.6001-1(a), (e), Income Tax Regs.       Respondent’s disallowance of

the deduction is sustained.

3.   Accuracy-Related Penalty

     Respondent determined that petitioner is liable for the

accuracy-related penalty under section 6662(a) with respect to the

portion of the underpayment attributable to the omission of the
                              - 18 -

Schedule C gross receipts.   Respondent did not determine that

petitioner is liable for the accuracy-related penalty with respect

to any other adjustment in the notice of deficiency.

     Section 6662(a) imposes a 20-percent penalty on the portion

of an underpayment attributable to any one of various factors, one

of which is negligence or disregard of rules or regulations.     Sec.

6662(b)(1).   “Negligence” includes any failure to make a

reasonable attempt to comply with the provisions of the Internal

Revenue Code, including any failure to keep adequate books and

records or to substantiate items properly.     Sec. 6662(c); sec.

1.6662-3(b)(1), Income Tax Regs.   Section 6664(c)(1) provides that

the penalty under section 6662(a) shall not apply to any portion

of an underpayment if it is shown that there was reasonable cause

for the taxpayer’s position and that the taxpayer acted in good

faith with respect to that portion.     The determination of whether

a taxpayer acted with reasonable cause and in good faith is made

on a case-by-case basis, taking into account all the pertinent

facts and circumstances.   Sec. 1.6664-4(b)(1), Income Tax Regs.

The most important factor is the extent of the taxpayer’s effort

to assess his proper tax liability for the year.     Id.

     It is clear that petitioner was negligent with respect to the

omission of the Schedule C income.     Petitioner did not keep

adequate books and records or otherwise substantiate the amount of

income reported on his return, as required by the Internal Revenue
                              - 19 -

Code.   The evidence petitioner did provide that shows certain

amounts of income that he received in the year in issue does not

correspond to the total amount reflected on his return.     Nor does

the amount of income reported on his return correspond to the

Forms 1099-MISC which petitioner was issued.     Despite being

involved in transactions resulting in bank deposits of over

$325,000, petitioner testified that “I also am mindful of the fact

that there’s probably a valid criticism that could be made of me

because I do not keep records that are precise, that can be added

up and totaled.”   We sustain respondent’s determination with

respect to the section 6662(a) accuracy-related penalty, as

modified by respondent’s concession concerning the amount of

unreported income.

     Reviewed and adopted as the report of the Small Tax Case

Division.

                                    Decision will be entered

                               under Rule 155.
