                        T.C. Memo. 2005-63



                      UNITED STATES TAX COURT



           EDGAR B. AND MONICA ALACAN, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 9088-02.                 Filed March 30, 2005.


     Edgar B. and Monica Alacan, pro sese.

     Diana P. Hinton, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     HAINES, Judge:   Respondent determined a deficiency of

$87,751 in petitioners’ Federal income tax for 1999.   The issues

for decision are: (1) Whether petitioners are entitled to claim

certain expenses as an exclusion from income and as deductions

for 1999; and (2) whether petitioners are liable for an increased

deficiency on the basis of a State income tax refund and interest
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income on such refund received in 1999 but not reported on their

1999 tax return.

     Unless otherwise indicated, all Rule references are to the

Tax Court Rules of Practice and Procedure, and all section

references are to the Internal Revenue Code, as amended.

                         FINDINGS OF FACT

     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.    At the time they filed

the petition, petitioners resided in Staten Island, New York.

     Petitioners filed their 1998 tax return with the filing

status of “Married filing joint return”.    On their Schedule A,

Itemized Deductions, petitioners claimed $18,497 for State and

local income taxes paid in 1998.

     During 1999, petitioners received a refund of $14,984 of the

amount paid on their 1998 State income taxes and interest income

on the refund of $149.35.

     Petitioners filed their 1999 tax return with the filing

status of “Married filing joint return”.    Petitioners did not

report any income for “Taxable refunds, credits, or offsets of

state and local income taxes”.    Petitioners excluded $236,761

from gross income.   Attached to the 1999 tax return is a letter

dated January 31, 2000, which states:

          This letter is to confirm that Edgar B. Alacan, as an
     employee of J.W. Barclay & Co., sustained $236,761 in after
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     tax expenses for the 1999 tax year. * * * A detailed list of
     all transactions will be provided if needed by request.

Petitioners also claimed $40,248 as “Unreimbursed employee

expenses” on the Schedule A.

     On April 3, 2002, respondent sent petitioners a notice of

deficiency in which respondent determined a deficiency of

$87,751.   Respondent disallowed petitioners’ exclusion from gross

income of $236,761, explaining that the amount “has been adjusted

to the amount verified.”   Further, respondent disallowed

petitioners’ claimed employee business expense of $40,248

reported on the Schedule A, explaining that “you did not

establish that the business expense shown on your tax return was

paid or incurred during the taxable year and that the expense was

ordinary and necessary to your business”.

     On May 28, 2002, the Court filed petitioners’ petition

disputing $39,826 of respondent’s disallowance of business

expenses and the exclusion from gross income of $236,761.

Petitioners argued that they could substantiate the disallowed

amounts.

     On June 19, 2003, respondent filed an amended answer with

leave of the Court in which respondent alleged that the

deficiency of $87,751 should be increased to $93,923 to reflect

petitioners’ receipt of a refund of their 1998 State and local

income taxes plus interest income on such refund which was

unreported as income on the 1999 tax return.
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                             OPINION

I.   Claimed Expenses

     Deductions are a matter of legislative grace, and a taxpayer

bears the burden of proving that he has complied with the

specific requirements for any deduction he claims.1   See INDOPCO,

Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice

Co. v. Helvering, 292 U.S. 435, 440 (1934).

     Under section 162, a taxpayer may deduct all ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on any trade or business if the taxpayer maintains

records or other proof sufficient to substantiate the expenses.

Sec. 162(a); sec. 6001; Deputy v. duPont, 308 U.S. 488, 495-496

(1940); sec. 1.6001-1(a), Income Tax Regs.

     If a claimed business expense is deductible, but the

taxpayer is unable to substantiate it, we are generally permitted

to approximate the amount of the expense, bearing heavily against

the taxpayer whose inexactitude is of his own making.    Cohan v.

Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930).    The estimate,

however, must have a reasonable evidentiary basis.    Vanicek v.

Commissioner, 85 T.C. 731, 743 (1985).




     1
        Petitioners do not argue that the burden of proof shifts
to respondent pursuant to sec. 7491(a) and that the threshold
requirements of sec. 7491(a) have been met. In any event, we
decide the issue on the basis of the preponderance of evidence on
the record.
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      Petitioners failed to provide substantiation for any of the

claimed expenses that respondent disallowed.    During trial,

petitioners did not provide any testimony or written

documentation for substantiation purposes.   Further, we find that

petitioners put forth little effort in trying to obtain the

required documentation since they became aware of the deficiency

more than 2 years ago.

      As a result, we hold that petitioners are not entitled to

claim the disputed expenses as deductions.   In light of the lack

of evidence on the record substantiating any of petitioners’

claimed expenses, we also hold that petitioners are not entitled

to exclude the disputed expenses from income.

II.   State Income Tax Refund

      Generally, if an amount was deducted on a prior year’s tax

return which resulted in a reduction of tax and a tax benefit to

the taxpayer, a subsequent recovery by the taxpayer of such

amount must be included in gross income in the year the recovery

is received.   Sec. 111(a); Kadunc v. Commissioner, T.C. Memo.

1997-92.   Therefore, gross income includes a refund of State

income tax in the year received to the extent that the payment of

such tax was claimed as a deduction in a prior taxable year which

resulted in a reduction of Federal income tax.    See Kadunc v.

Commissioner, supra.
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     The burden of proof with regard to this issue is on

respondent because he asserted an increased deficiency in an

amended pleading.   Rule 142(a).   Respondent established

petitioners’ receipt of the State income tax refund and

accompanying interest income by placing into evidence certified

documents from the New York State Department of Taxation and

Finance, which report that petitioners received a State income

tax refund and interest income with regard to the State income

taxes paid for 1998 in 1999.   Further, the parties placed into

evidence petitioners’ 1998 tax return, which reported a claimed

deduction for State income taxes paid in 1998 that reduced

petitioners’ tax for 1998, and petitioners’ 1999 tax return,

which did not report as income the State income tax refund and

interest income received in 1999.

     Petitioners did not provide any evidence to dispute their

receipt of the refund and interest income in 1999 and their

failure to report such as income on their 1999 tax return.    In

fact, the parties stipulated that petitioners received the State

income tax refund and applicable interest income in 1999 and did

not include such income on their 1999 tax return.    On the basis

of the evidence on the record, we hold that petitioners are

liable for the increased deficiency because of their receipt of a

State income tax refund and applicable interest income during

1999.
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     In reaching our holdings herein, we have considered all

arguments made, and, to the extent not mentioned above, we

conclude that they are irrelevant or without merit.

     To reflect the foregoing,


                                              Decision will be

                                         entered for respondent.
