                            T.C. Memo. 1998-282



                          UNITED STATES TAX COURT



           ROBERT A. INZANO and MARTHA O. CHAVEZ, Petitioners v.
                COMMISSIONER OF INTERNAL REVENUE, Respondent


       Docket No. 2404-96.                        Filed August 5, 1998.


       Robert A. Inzano, pro se.


       Scott Hargis, for respondent.


                            MEMORANDUM OPINION

       NAMEROFF, Special Trial Judge:     This case was heard pursuant

to the provisions of section 7443A(b)(3)1 and Rules 180, 181, and

182.       Respondent determined a deficiency in petitioners’ 1990

Federal income tax in the amount of $6,631 and an addition to tax


       1
        Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year at issue. All
Rule references are to the Tax Court Rules of Practice and
Procedure.
                                - 2 -


under the provisions of section 6651(a)(1) in the amount of

$1,658.    After a concession by petitioners regarding unreported

dividend income, the issues for decision are:    (1) Whether

petitioners are able to substantiate claimed Schedule C expenses;

and (2) whether petitioners are liable for the addition to tax

for delinquency.

Background

     Some of the facts have been stipulated, and they are so

found.    The stipulation of facts and the attached exhibits are

incorporated herein by this reference.    At the time they filed

their petition, petitioners resided in San Clemente, California.

     In approximately September 1989, petitioners purchased a

business known as Joan’s Dust Busters (JDB) allegedly for

$125,000.    The business of JDB was to clean a newly built home

for occupancy.    JDB had contacts with several residential home

developers.    Just prior to the move-in by the new owner, the

developer would contact petitioners, who would send one or more

workers (depending on the size of the home) to vacuum the new

carpets, remove “sticky stuff” from and clean newly installed

windows, and conduct other general cleaning operations.    In

addition, petitioners had agreements with developers regarding

model homes, in that petitioners would have the developers’ model

homes cleaned on a regular, generally monthly, basis.

Petitioners’ purchase of JDB included some equipment, which was
                                - 3 -


in a state of disrepair, and a few supplies, but primarily

petitioners purchased the name, goodwill, and purported contacts

of the seller.    Ultimately, the petitioners discovered that the

representations by the seller were, to be charitable, overstated,

and petitioners stopped paying on the purchase price and sued the

seller.    According to petitioner husband, the law suit was

unsuccessful.

     JDB charged clients based upon the size of the residence to

be cleaned.   Charges generally ranged from $225 to $325.   The

labor costs for cleaning generally ran from $50 to $65 per person

per day.   Normally, most homes could be cleaned by two persons in

a day and a half, although larger homes required more persons or

more time.

     Petitioners maintained most records for JDB on a computer.

In December 1993, petitioners suffered a loss of their home from

fire.   Most paper records were destroyed, and water damage to the

computer prevented any retrieval of its records.

     Petitioners did not file a timely 1990 Federal income tax

return, because in the opinion of petitioner husband, there was

no tax liability.    However, in response to an inquiry from

respondent’s agents, petitioners, on April 19, 1994, filed a

joint Federal income tax return, Form 1040.    Included in that

return was a Schedule C for JDB reflecting income of $27,165 and

the following expenses:
                               - 4 -


          Advertising                  $12,940
          Car and truck                  5,200
          Insurance                      5,400
          Legal                          3,100
          Office                         6,000
          Rent                           6,900
          Repairs and Maintence          2,100
          Supplies                       4,790
          Tax and licenses                 550
          Utilities                      3,150
            Total                       50,130

     In preparing their return, petitioners had to rely upon

estimates, for their records had been lost.      Thus, it is not

clear whether the income figure is accurate.      Moreover,

petitioners neglected to deduct their labor costs for the

cleaning help.2   In the notice of deficiency, respondent

disallowed all claimed expenses for lack of substantiation.        In

addition, respondent determined that there was no reasonable

cause for the delinquent filing and asserted the addition to tax

under section 6651(a)(1).

Discussion

     Section 162(a) allows the deduction of “ordinary and

necessary” expenses paid or incurred during the taxable year in

carrying on any trade or business.     Deductions are a matter of

legislative grace, and taxpayers must prove that they are

entitled to the claimed deductions.     Rule 142(a); INDOPCO, Inc.

v. Commissioner, 503 U.S. 79, 84 (1992).     They must keep

     2
        JDB had no employees. All cleaning work was done by
petitioners and “subcontractors” hired at the time work was
required.
                                - 5 -


sufficient records to establish deduction amounts.    Sec. 6001;

Meneguzzo v. Commissioner, 43 T.C. 824, 831-832 (1965).

Generally, except as provided by section 274(d), when evidence

shows that a taxpayer incurred a deductible expense, but the

exact amount cannot be determined, the Court may approximate the

amount.    Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir.

1930).    The Court, however, must have some basis upon which an

estimate may be made.    Vanicek v. Commissioner, 85 T.C. 731, 742-

743 (1985).

     A strict substantiation requirement exists under section

274(d)(4) for certain items listed under section 280F(d)(4) such

as passenger automobiles.    Taxpayers must substantiate by

adequate records the following items in order to claim automobile

deductions:    The amount of each automobile expenditure, the

automobile’s business and total usage, the date of the

automobile's use, and the automobile's business purpose.      Sec.

274(d); secs. 1.274-5T(b)(6), 1.274-5T(c)(1), Temporary Income

Tax Regs., 50 Fed. Reg. 46016 (Nov. 6, 1985).

     To substantiate a deduction by means of adequate records, a

taxpayer must maintain an account book, diary, log, statement of

expense, trip sheets, and/or other documentary evidence which, in

combination, are sufficient to establish each element of

expenditure or use.    Sec. 1.274-5T(c)(2)(i), Temporary Income Tax

Regs., 50 Fed. Reg. 46017 (Nov. 6, 1985).    Section 274(d) is an
                               - 6 -


exception to the Cohan rule and prohibits the estimation of these

expenses.   Sanford v. Commissioner, 50 T.C. 823, 827-828 (1968),

affd. per curiam 412 F.2d 201 (2d Cir. 1969); sec. 1.274-5T(a),

Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985).

     The loss of tax records does not leave a taxpayer helpless

in meeting his substantiation burden.   In general, when a

taxpayer's records have been lost or destroyed through

circumstances beyond his control, he is entitled to substantiate

the deductions by reconstructing his expenditures through other

credible evidence.   Malinowski v. Commissioner, 71 T.C. 1120,

1125 (1979); Cook v. Commissioner, T.C. Memo. 1991-590.

     Before we discuss each item of expenditure, we must briefly

comment on the history of this litigation.   Subsequent to the

filing of the petition on April 25, 1996, this case was first

calendared for trial in Los Angeles, California, on March 10,

1997.   On that date, petitioner husband appeared and requested a

continuance on the grounds that he was trying to obtain

“additional” records from the attorney who had been handling

petitioners’ litigation against the seller of JDB.   The case was

continued and recalendared for trial for June 2, 1997.    On May

28, 1997, petitioners moved for a continuance on the grounds that

they had served a subpoena on Wells Fargo Bank, the successor to

their bank, First Interstate, and that there would be a delay in

the bank’s compliance therewith.   Petitioners’ motion was
                                 - 7 -


granted, and the case was recalendared for September 22, 1997.

Finally, the case was continued from that date and recalendared

for January 26, 1998.     The Court notes that the only records

obtained by petitioners during this entire period and submitted

in evidence were 15 canceled checks for the period June 26, 1990,

through July 12, 1990.

     a.    Advertising.   Petitioner testified that JDB did

extensive advertising by flyer and in the “Yellow Pages” of the

telephone book.   Considering the nature of the business, we are

surprised by this claim, in that petitioners’ clients were real

estate developers and not the general public.     Moreover, it would

have been a simple task to contact the telephone company or

printers to obtain verification of their claimed advertising

expense.   On this record, we cannot allow any amount for

advertising.

     b.    Car and truck.   Petitioner claimed that they had two

vehicles solely for business, in addition to petitioner wife’s

personal auto, which was used for nonbusiness purposes.       However,

no records were ever maintained for the vehicles’ usages, no

records were kept for the actual expenses incurred for these

vehicles, and no evidence was submitted regarding their cost.

Accordingly, because there is no compliance with the requirements

of section 274(d), no amount can be allowed for car and truck

expense.
                                 - 8 -


     c.    Insurance.   Petitioners claim insurance expense for

their business liability insurance and for their vehicle

insurance.   As to the latter, petitioners must still comply with

the provisions of section 274(d) as described above, and having

failed to do so, cannot deduct any amount for vehicle insurance.

Moreover, the record does not contain any information as to

vehicle insurance costs.

     With regard to the business liability insurance, petitioners

contend that they carried a large policy with Ohio Casualty,

which required a substantial down payment and monthly payments of

$147.99.   The record contains one check to the insurance broker

stated to be a monthly payment thereof.      The record was left open

in this case for 60 days for petitioners to contact their

insurance company for documentary verification of their claim.

Nothing was received from petitioners in this regard.3      From this

record, we are satisfied that petitioners paid the regular

monthly premiums for the business insurance, but there is no

evidence of the existence, amount, or date of payment of the

alleged “substantial downpayment.”       Accordingly, we hold that




     3
        Indeed, as will be noted, the record was left open for
several reasons, all to no avail. Petitioners did submit a
Motion to Supplement the Record with regard to the home office
deductions, but did not attach any documentation thereto. The
record had not been held open for this purpose, and the motion
was denied.
                                  - 9 -


petitioners are entitled to a deduction for business insurance

for $1,775.88, representing 12 monthly payments of $147.99.

     d.     Legal.   Petitioner stated the names of several attorneys

with whom JDB had some relationships, but he was not able to

describe those relationships or indicate the amounts of the

respective legal fees paid.     The Court kept the record open for

60 days in order for petitioner to contact those attorneys to

obtain substantiating documentation.      Nothing has been received

from petitioners.      Accordingly, we are unable to speculate on the

amount of legal fees petitioners expended as ordinary and

necessary business expenses, or to allow a deduction for any such

fees.     Vanicek v. Commissioner, supra.

     e.    Home office. The claimed deductions for office expense,

rent expense, and utilities all pertain to this subject.     Suffice

it to say that petitioners have failed to show that they used and

maintained regularly and exclusively any part of their home for

business purposes or any verification of the claimed

expenditures.    We sustain respondent’s disallowance of these

items.

     f.     Repairs.   We are not sure what this claimed expenditure

consists of, although vehicle repairs probably make up the

largest part thereof, if not all.     Any vehicular repair expenses

would be covered by the rules of section 274(d).     As to any other
                                  - 10 -


repairs, no substantiating evidence was presented.      We sustain

respondent’s disallowance of this item.

     g. Supplies.      Petitioners purchased supplies such as window

washing solution and a compound used for removing materials stuck

to glass.    Canceled checks submitted verify the purchase of

supplies on July 7, 1990, for $42.50.       On this record and using

our best judgment, we allow petitioners a deduction for supplies

of $600.    Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930).

     h.     Taxes and licenses.   Petitioner testified that he had to

purchase a municipal business license whenever JDB had to go into

a new municipality.     Each license was valid for one year.   We

kept the record open for petitioners to contact the various

municipalities to obtain substantiating documentation.      Nothing

was received.    On this record, we have no basis upon which to

estimate or allow a deduction for expenses for licenses.       Vanicek

v. Commissioner, 85 T.C. 731 (1985).

     i.     Labor.   We find that petitioners hired outside labor to

perform the services required.      We also find that petitioners

performed some of the services themselves.      Canceled checks for

such labor for the period June 26, 1990, through July 7, 1990,

totaled $2,890.      Based upon this record, we allow petitioners a

deduction for labor of $10,000.      Cohan v. Commissioner, supra.

     The final issue to be decided is whether petitioners are

liable for an addition to tax pursuant to section 6651(a)(1).
                               - 11 -


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

timely a tax return unless it is shown that such failure is due

to reasonable cause and not willful neglect.   A taxpayer can

establish reasonable cause by showing that, despite the exercise

of ordinary care and prudence, the taxpayer was unable to file

the required tax return within the prescribed time.     United

States v. Boyle, 469 U.S. 241, 246 (1985); Crocker v.

Commissioner, 92 T.C. 899, 913 (1989); sec. 301.6651-1(c)(1),

Proced. and Admin. Regs.   Willful neglect has been defined as a

conscious, intentional failure or reckless indifference to timely

filing a return.   United States v. Boyle, supra at 245.

Petitioners have the burden of proof.   Rule 142(a).

     It is undisputed that petitioners did not timely file their

individual tax return for taxable year 1990.   Petitioners argue

that they had no expectation that any tax was due, because JDB’s

business was not profitable.

     We conclude that petitioners have not met their burden of

proof.   An unverified belief that no taxes are owing does not

constitute reasonable cause of the sort that will allow

petitioners to escape the addition to tax pursuant to section

6651(a)(1).   Olsen v. Commissioner, T.C. Memo. 1993-432, and

cases cited therein. The question is not whether petitioners

thought that they owed tax, but whether they knew or should have

known that they needed to file a return.   Jackson v.
                             - 12 -


Commissioner, 864 F.2d 1521, 1527 (10th Cir. 1989), affg. 86 T.C.

492 (1986); Olsen v. Commissioner, supra.   Consequently, we hold

that petitioners have not established reasonable cause for their

failure to file timely their 1990 tax return.   Accordingly,

petitioners are liable for the section 6651(a)(1) addition to tax

relating to their tax liability for taxable year 1990.

     To reflect the foregoing and the parties’ concessions,



                                        Decision will be entered

                                   under Rule 155.
