                         T.C. Memo. 2003-161



                       UNITED STATES TAX COURT



       ROBERT E. AND YVONNE R. KOVACEVICH, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 12815-99.               Filed June 3, 2003.



     Robert E. Kovacevich and Richard W. Kochansky, for

petitioners.

     Milton B. Blouke and Roger P. Law, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


     FOLEY, Judge:    By notice of deficiency dated April 28, 1999,

respondent determined deficiencies, additions to tax, and

penalties relating to petitioners’ 1992 through 1994 Federal

income tax returns as follows:
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                              Addition to Tax         Penalty
     Year       Deficiency     Sec. 6651(a)        Sec. 6662(b)(1)
     1992        $18,232          $1,330               $3,176
     1993          8,347           1,442                  --
     1994         13,074             -–                 2,615

     After concessions by both parties, the section 6651(a)(1)

addition to tax relating to 1992 and all issues relating to 1993

were settled.   The remaining issues for decision are whether:

(1) Petitioners failed to report income that Robert E. Kovacevich

(petitioner) received from Western Management, Inc. (Western);

(2) income reported by petitioners is properly classified as

gross receipts from a Schedule C business rather than as wages;

(3) petitioners are entitled to certain business deductions; and

(4) petitioners are liable for section 66621 penalties.

                         FINDINGS OF FACT

     Petitioner was admitted to practice law in the State of

Washington in 1959.   In 1981, petitioner incorporated Robert E.

Kovacevich, P.S., a Washington C corporation, whose name was

subsequently changed to Western Management, Inc.   From its

incorporation through 1994, Western’s only source of income was

from the provision of legal services, and petitioner was

Western’s sole shareholder, president, and secretary-treasurer.

In 1981, Western’s board of directors voted to pay petitioner



     1
        Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
                                - 3 -

$28,000 in 1982 and $60,000, annually, thereafter.    Petitioner

designated Seattle First National Bank, Spokane and Eastern

Branch (Seafirst), as the depository for all of Western’s funds.

All moneys that were paid on Western’s accounts receivable were

deposited in the Seafirst account.

     Petitioner worked 160 to 180 hours per month for Western and

performed all services necessary to generate Western’s gross

receipts.    From 1992 through 1995, petitioner made all major

decisions for Western including:    Paying creditors, hiring

employees, signing checks, determining employee compensation,

renewing Western’s malpractice insurance, and signing Western’s

Federal tax returns.    No other person performed legal services on

behalf of Western.

     Petitioner received funds from Western as his needs arose

and was not compensated for his services at predetermined

intervals.   In 1992 and 1994, respectively, Western paid

petitioner $135,000 and $132,000.    Western issued checks to

petitioners and their creditors (e.g., Nordstrom, Teneff Jewelry,

Fit and Hollywood, and National Golf), and petitioner informed

Western’s accountant and tax return preparer, Bob Moe and

Associates (Moe), that these payments were draws.    Western

classified the payments as “loans” on its corporate ledgers and

did not file Forms 1099-MISC, Miscellaneous Income, relating to

the payments.   Western also paid petitioner’s law license renewal
                                - 4 -

fees, office expenses, bar dues, and health insurance premiums

and deducted most of these expenses on its corporate income tax

returns.

     Petitioners maintained, at Farmers and Merchants Bank, a

personal line of credit.   On the corporate ledgers, Moe listed

checks written to Farmers and Merchants Bank and MBNA in the

“Receivable from Officer” account.      These checks had an “LN” memo

description, indicating that the payment related to a loan or the

“Receivable from Officer” account.

     From 1982 through 1992, Western sponsored a defined benefit

plan for petitioner, its only participant.     In 1982 and 1984,

respectively, Western contributed $46,473 and $81,822 to the

plan.   In the early 1980s, petitioners and the pension plan

invested $160,000 (i.e., petitioners invested $70,000 and the

pension plan invested $90,000) in a business venture.

Petitioners and the pension plan later sued the venture’s

promoter and, in 1992, were awarded a $20,852 recovery of their

investment.   Petitioners retained the pension plan’s portion of

the recovery (i.e., $11,677).

     In 1984, petitioners bought a 1973 Rolls Royce for $27,000.

Petitioners used the Rolls Royce for business promotion in 1984

and 1985.   In 1985, the automobile’s engine failed, and, as a

result, petitioners were not able to use the automobile for

approximately 2-1/2 years.
                              - 5 -

     With input from Moe, petitioners prepared and filed their

1992 and 1994 joint tax returns.    On the Schedule C, Profit or

Loss From Business, attached to their 1992 individual income tax

return, they reported $103,046 in gross receipts relating to

Western’s law practice (i.e., $90,000 of compensation and $13,046

of rent payments from Western).    On the Schedule C attached to

their 1994 individual income tax return, they reported $102,565

in gross receipts relating to Western’s law practice (i.e.,

$90,000 of compensation and $12,565 of rent payments from

Western) and a $1,475 depreciation deduction relating to the

automobile.

     Western’s fiscal year ends on March 31.    On its 1992, 1993,

1994, and 1995 corporate income tax returns, Western deducted

officers’ compensation expenses in the amounts of $135,000,

$144,000, $132,000, and $133,000, respectively.    Petitioner

amended Western’s 1991 Form 941, Employer's Quarterly Federal Tax

Return, with the following statement:

     The amount of earnings of Employee Robert E. Kovacevich
     was not clear, hence was left off. The Employee paid
     all Income Tax due, hence the withholding is
     unnecessary. However the Social Security Tax is due.
     A completed W-2(c) term is included.

     On September 30, 1995, Western made a payment of $22,583 in

income tax withholding relating to petitioners’ 1992 and 1993

employment taxes.
                               - 6 -

     In 1991, a former client, Terry Stokke, sued petitioner for

allegedly committing fraud with respect to a pooled investment.

Petitioner settled the lawsuit in 1992 for $39,000 and reported

this amount as a Schedule C expense on their 1992 tax return.

     At the time the petition was filed, petitioners resided in

Spokane, Washington.

                              OPINION

I.   Jurisdiction

     On October 18, 2000, the Court filed petitioners’ Motion To

Dismiss “Wages” Issue In 1992 For Lack Of Jurisdiction, in which

petitioners contended that Western’s 1995 payment of $22,583.20

in income tax withholding discharged petitioners’ tax liability

relating to petitioners’ 1992 unreported wages.     We disagree.

Congress has specifically given this Court jurisdiction to

redetermine a deficiency if a valid notice of deficiency has been

issued and a petition has been timely filed.     Secs. 6212(a),

6213(a), and 6214(a); Rule 13(a), (c); Monge v. Commissioner, 93

T.C. 22, 27 (1989); Normac, Inc. v. Commissioner, 90 T.C. 142,

147 (1988).   Therefore, petitioners’ motion will be denied.

     Petitioners further contend that the notice of deficiency is

invalid because respondent did not make a determination.     In

support of their position, petitioners state that “the

unexplained arrows and rounding of * * * [the amounts of the

deficiencies] indicate vagueness.”     In the notice, respondent
                                  - 7 -

determined deficiencies in the amounts of $18,232 and $13,074

relating to 1992 and 1994, respectively.      See Perlmutter v.

Commissioner, 44 T.C. 382, 400 (1965)(holding that a valid notice

of deficiency indicates that the respondent has determined a

deficiency in tax in a definite amount for a particular taxable

year and intends to assess the tax in due course), affd. 373 F.2d

45 (10th Cir. 1967).      A notice of deficiency is not invalid for

failure to explain the adjustments or to cite statutory

provisions on which respondent relied.      See, e.g., Henry Randolph

Consulting v. Commissioner, 113 T.C. 250, 253 (1999); Campbell v.

Commissioner, 90 T.C. 110 (1988); Mayerson v. Commissioner, 47

T.C. 340, 348-349 (1966); St. Paul Bottling Co. v. Commissioner,

34 T.C. 1137 (1960).      Accordingly, we reject petitioners’

contention.

II.   Unreported Income

      Petitioners contend that it was inappropriate for respondent

to use the “specific item” method to determine petitioners’

deficiencies.   The “specific item” method is an indirect method

of income reconstruction, which consists of evidence of specific

amounts of income received by a taxpayer and not reported on the

taxpayer’s return.     Estate of Beck v. Commissioner, 56 T.C. 297,

361 (1971).   It is well settled that taxpayers are required to

report every item of income received and maintain records to

establish the correct amount of income, deductions, and credits
                                - 8 -

required to be shown on their tax returns.    Petzoldt v.

Commissioner, 92 T.C. 661, 687 (1989).    Petitioners failed to

keep sufficient records.    Thus, respondent was justified in using

the “specific item” method of proof to determine petitioners' tax

liabilities relating to 1992 and 1994.    See Estate of Beck v.

Commissioner, supra at 353-354 (“there is no restriction on the

method or theories by which respondent may test his views that

unreported income exists provided they are reasonably calculated

to disclose the presence or absence of unreported income”).

Accordingly, we reject petitioners’ contention.2

     Petitioner received $135,000 and $132,000 relating to 1992

and 1994, respectively.    Petitioners, however, reported only

$90,000 in compensation in each year.    Petitioners failed to

establish that the checks written for petitioners’ benefit

(e.g., checks written to petitioners’ creditors) were not

includable in their gross income and failed to adequately rebut

respondent’s determination of unreported income.    Therefore, we

conclude that petitioners failed to report additional income in

the amounts of $45,000 (i.e., $135,000 income received minus



     2
        The burden of proof is on petitioners to show that
respondent’s deficiency determination is incorrect. Rule 142(a);
Welch v. Helvering, 290 U.S. 111 (1933). Sec. 7491 is
inapplicable because the examination began before July 22, 1998,
the section’s effective date. Internal Revenue Service
Restructuring & Reform Act of 1998, Pub. L. 105-206, sec.
3001(c), 112 Stat. 685, 726.
                                - 9 -

$90,000 income reported) and $42,000 (i.e., $132,000 income

received minus $90,000 income reported) relating to 1992 and

1994, respectively.

III. Employment Status

     Respondent determined in the notice of deficiency that

payments from Western, reported on petitioners’ Schedule C, are

wage compensation and the business expenses deducted by

petitioners are miscellaneous itemized deductions.    Respondent

contends that petitioner was an employee of Western because he

was an officer who performed substantial services.    Petitioner,

relying on several contentions that have been rejected in similar

circumstances, contends that he was not an employee of Western.

     Pursuant to section 3121(d)(2), the term “employee” includes

any individual who has the status of an employee under the

applicable common law rules.    Paragraphs (1), (3), and (4) of

section 3121(d) delineate “statutory employees”.     These

individuals are considered employees regardless of their status

under the common law.    See Joseph M. Grey Pub. Accountant, P.C.

v. Commissioner, 119 T.C. 121, 126 (2002).    Any officer of a

corporation is a statutory employee, if such officer performs

substantial services for a corporation and receives remuneration

for those services.   See Veterinary Surgical Consultants, P.C. v.

Commissioner, 117 T.C. 141 (2001), affd. sub nom. Yeagle Drywall
                                - 10 -

Co. v. Commissioner, 54 Fed. Appx. 100 (3d Cir. 2002); sec.

31.3121(d)-1(b), Employment Tax Regs.     Petitioner was a statutory

employee because at all relevant times he served as Western’s

president, worked in all significant aspects of Western’s

business, performed substantial services for Western in his

capacity as an officer, and obtained remuneration for such

services from Western as his needs arose.

IV.   Pension Plan Recovery

      Petitioners received and retained an $11,677 recovery that

belonged to the pension plan.    Petitioners contend that these

funds were rolled over into an Individual Retirement Account, but

their testimony on this issue was unconvincing, and they did not

present any supporting documentation.     Accordingly, the $11,677

must be included in income.

V.    Schedule C Expenses

      For depreciation purposes, automobiles are classified as 3-

year property.   Rev. Proc. 83-35, 1983-1 C.B. 745.    The period

for depreciation of an asset begins when the asset is placed in

service and ends when the asset is retired from service.     Sec.

1.167(a)-11(e)(1), Income Tax Regs.      Petitioners contend that the

automobile was not placed in service until 1990 because the

engine failed in 1985, and the automobile could not be used for a

few years.   Petitioners further contend that, pursuant to section
                                 - 11 -

280F, which limits the deduction of luxury automobiles, they are

entitled to a $1,417 deduction relating to 1994.

        Petitioners bought the Rolls Royce for $27,000 in 1984 and

placed it in service that year.      Once placed in service

depreciation continues until the cost basis of the property has

been either recovered through previously allowed or allowable

depreciation deductions or the property is retired from service

(i.e., sold, abandoned, or destroyed).      Sec. 1.167(a)-10, Income

Tax Regs.; Rev. Proc. 87-57, sec. 2.05, 1987-2 C.B. 687, 688.

Petitioners’ automobile was not retired from service prior to the

years in issue.     Thus, pursuant to section 280F(a), the

automobile would have been fully depreciated well before

petitioners filed their 1994 return, on which they deducted the

$1,475.     Sec. 280F(a)(2)(B)(iv); sec. 1.167(a)-10(a), Income Tax

Regs.     Accordingly, their deduction is disallowed.   Because

petitioner is an employee of Western, we also hold that the

$39,000 expense is deductible as a miscellaneous itemized

deduction.     Sec. 67(a).

VI.   Penalties

        Section 6662(a) imposes a 20-percent accuracy-related

penalty on the portion of an underpayment of tax which is

attributable to a taxpayer’s negligence or disregard of rules or

regulations.      Sec. 6662(b)(1).   Section 6664(c)(1) provides that

no penalty shall be imposed if it is shown that there was
                                - 12 -

reasonable cause for the underpayment and that the taxpayer acted

in good faith.   The determination of whether a taxpayer acted

with reasonable cause and in good faith depends upon the facts

and circumstances.    See sec. 1.6664-4(b)(1), Income Tax Regs.

Reliance on the advice of an accountant may demonstrate

reasonable cause and good faith.     See id.    Petitioners contend

that they relied in good faith on the advice of Moe, but

petitioners did not provide Moe with accurate information (e.g.,

mischaracterizing payments made by Western to various creditors

of petitioners as loans instead of wages).       Under such

circumstances, reliance on an accountant's advice is not in good

faith and does not establish that the taxpayer acted with

reasonable cause.     See Paula Constr. Co. v. Commissioner, 58 T.C.

1055, 1061 (1972), affd. without published opinion 474 F.2d 1345

(5th Cir. 1973).     Moreover, petitioner is an experienced tax

lawyer who manipulated income received from Western.       Petitioner

did not exercise due care in the filing of his return and thus is

liable for the section 6662(a) penalty.        Welch v. Helvering, 290

U.S. 111, 115 (1933).

     Contentions we have not addressed are irrelevant, moot, or

meritless.
                        - 13 -

To reflect the foregoing,



                                    An order denying

                             petitioners’ motion to dismiss

                             will be issued, and decision

                             will be entered under Rule

                             155.
