                              T.C. Memo. 2013-257



                        UNITED STATES TAX COURT



      KULWANT S. PAWAR AND KARMJIT K. PAWAR, Petitioners v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 27396-11.                      Filed November 12, 2013.


      Jagdip Singh, for petitioners.

      Sarah E. Sexton, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      LARO, Judge: The instant petition involves petitioners’ 2005, 2006, and

2007 Federal income tax returns. Petitioners seek redetermination of respondent’s
                                        -2-

[*2] determinations of deficiencies, an addition to tax under section 6651(a)(1),1

and accuracy-related penalties under section 6662(a) as follows:

                                      Addition to tax       Penalty
                Year Deficiency       sec. 6651(a)(1)     sec. 6662(a)
                2005 $80,212              $20,053           $16,042
                2006   97,820                ---              19,564
                2007   30,955                ---               6,191

      Following the parties’ stipulations,2 the following issues remain for us to

decide:

      (1) whether petitioners had additional income from sales of $243,184 for

20063 and $73,307 for 2007 which they failed to report on their Schedules C,



      1
       Unless otherwise indicated, section references are to the Internal Revenue
Code in effect for the years at issue, and Rule references are to the Tax Court
Rules of Practice and Procedure.
      2
        The parties stipulated the following before trial: (1) petitioners received
$11,940 of cancellation of indebtedness income in 2005; (2) petitioners are
entitled to deduct an additional $5,866 of Schedule C advertising expenses for
2005; (3) petitioners received an additional $3,000 of Schedule C gross receipts or
sales in 2005; (4) petitioners are entitled to deduct an additional $1,289 of
Schedule C other expenses for 2005; (5) petitioners are entitled to deduct $97,239
of Schedule C taxes and licenses for 2005; (6) petitioners received $3,701 of
cancellation of indebtedness income for 2006; and (7) petitioners are entitled to
deduct an additional $3,595 of Schedule C advertising expenses for 2006.
      3
        On April 6, 2006, Wells Fargo Bank erroneously deposited $14,403.86 into
petitioners’ bank account ending in 4843, which was later returned to the bank
when the mistake was discovered. Respondent concedes that this $14,403.86 is
nontaxable.
                                            -3-

[*3] Profit or Loss From Business, as gross receipts or sales. We hold that they

did to the extent stated in this opinion;

       (2) whether petitioners are entitled to deduct certain Schedule C other

expenses for 2006 and 2007 in excess of what respondent allowed. We hold they

are not;

       (3) whether petitioners are entitled to deduct certain Schedule C advertising

expenses for 2007 in excess of what respondent allowed. We hold they are not;

       (4) whether petitioners are entitled to deduct certain Schedule C taxes and

licenses expenses for 2006 and 2007 in excess of what respondent allowed. We

hold they are not;

       (5) whether petitioners are entitled to Schedule C costs of goods sold for

2005, 2006, and 2007 in excess of what respondent allowed. We hold they are

not;

       (6) whether petitioners are liable for the addition to tax under section

6651(a)(1) for 2005. We hold that they are; and

       (7) whether petitioners are liable for accuracy-related penalties under

section 6662(a) for 2005, 2006, and 2007. We hold that they are.

       Petitioners resided in Manteca, California, when they filed their petition.
                                          -4-

[*4]                            FINDINGS OF FACT

       In 1997 petitioners came to the United States from India. In the United

States Mr. Pawar started out working as a cab driver before becoming a forklift

driver and, ultimately, a car salesman. Despite having only a fifth grade

education, Mr. Pawar was very successful at selling cars and eventually opened his

own dealership called Manteca Quality Auto Sales in 2001. As part of the

business, Mr. Pawar purchased cars and fixed them up for resale.

       Petitioners sold cars through their dealership (car lot sales) and at auction.

Cars sold through the dealership had to be registered with the State and reported to

the State Board of Equalization when sold. Ms. Pawar handled all the paperwork

connected with the car lot sales, including filing State taxes, paying bills, and

maintaining the books. When she did not know how to properly account for an

item, Ms. Pawar obtained advice from George Fakhouri, a certified public

accountant (C.P.A.) with over 40 years of experience. Neither Ms. Pawar nor

anyone else handled the paperwork in connection with petitioners’ auction sales.

Petitioners sold cars at auction for all three years at issue.

       For all three years at issue Mr. Fakhouri prepared petitioners’ Federal

income tax returns using the State sales tax returns from their dealership and

carbon copies of checks. According to Mr. Fakhouri, since all sales from the car
                                         -5-

[*5] lots were reported to the State, the sales tax returns had to be “absolutely

accurate”. However, petitioners did not provide any receipts, loan documents, nor

records of cash or cashier’s check transactions to Mr. Fakhouri for the preparation

of their tax return. Further, petitioners did not provide Mr. Fakhouri with records

of their auction sale activities because they failed to keep such records.

      Finally, petitioners did not file their 2005 tax return until March 26, 2007.

I.    IRS audits

      IRS Revenue Agent Charles Lion (Agent Lion) was assigned to audit

petitioners’ 2005 return. The 2005 audit eventually expanded to include

petitioners’ 2006 and 2007 returns as well.

      Throughout the audit Agent Lion worked closely with Mr. Fakhouri. He

routinely shared the results of the audit with Mr. Fakhouri and was receptive to

Mr. Fakhouri’s clarifications and suggestions. In addition to reviewing the

documents provided by Mr. Fakhouri for accuracy and completion, Agent Lion

further took care to remove duplicate copies of records so as not to account for

them more than once.

      A.     2005 audit

      For the 2005 audit Agent Lion determined gross receipts by comparing

petitioners’ tax return with four State Board of Equalization reports. His analysis
                                        -6-

[*6] revealed only slight discrepancies between the two. Agent Lion did not use

the bank deposits method to determine petitioners’ 2005 income. For petitioners’

2005 expenses Agent Lion performed a detailed analysis transaction by

transaction.

      B.       2006 and 2007 audits

      For the 2006 and 2007 audits Agent Lion determined petitioners’ income

using the bank deposits method. Agent Lion performed his analysis using

petitioners’ bank account statements, nearly all of which he obtained by summons.

To determine petitioners’ income, Agent Lion first totaled all deposits to

petitioners’ bank accounts and then subtracted amounts which were reasonably not

attributable to income, including electronic transfers between bank accounts,

checks returned for nonsufficient funds, returns of purchases, and returned bank

fees. Agent Lion was very responsive to Mr. Fakhouri’s opinions and suggestions

and frequently took them into account. Examples include deposits of State taxes

and gross rents, which Agent Lion subtracted from gross deposits at Mr.

Fakhouri’s suggestion. Indeed, Mr. Fakhouri testified that at one point he and

Agent Lion stepped through deposits one by one until Mr. Fakhouri could not

account for any of the remaining deposits. In August 2011 Agent Lion closed the

2005, 2006, and 2007 audits after he ceased to receive further responses or
                                                     -7-

[*7] substantiating documents from petitioners. In making allowances for

petitioners’ 2006 and 2007 expenses, Agent Lion used a sampling technique.

See Internal Revenue Manual pt. 4.46.4.2.10 (Mar. 1, 2006).

        C.       Summary of 2005, 2006, and 2007 audit results

        The following table summarizes the results of Agent Lion’s audits for

2005, 2006, and 2007.

                                      2005                     2006                       2007
             Items               Return       Exam         Return       Exam        Return          Exam

 Cancellation of debt income       -0-         $11,940      $3,340       $7,041        ---            ---
 Gross receipts or sales       $1,239,917    1,242,917   1,307,865    1,551,049   $1,115,714     $1,189,021
 Costs of goods sold            1,023,445      887,325   1,206,062    1,171,665      990,055        960,353
 Advertising expense               36,655       30,789      31,143       27,548       20,336         17,896
 Taxes and licenses                97,239        -0-        10,601        -0-           1,766          -0-
 Other expenses                     2,898        1,609         477          477       27,487         15,261


II.     Petitioners’ deposit and withdrawal activity

        Petitioners’ 2006 bank statements for their accounts ending in 4843, 9897,

and 8501 show a number of transactions in which deposits were made in one

account and withdrawals were made from another account in identical amounts

and close in time. The relevant transactions are summarized below.
                                         -8-

[*8]

                  Withdrawal                              Deposit
             Date Amount Account                 Date     Amount Account

           3/22/06   $5,000       8501         3/22/06     $5,000     4843
           3/31/06    1,000       8501         3/31/06      1,000     4843
           4/26/06    3,000       8501         4/25/06      3,000     4843
           5/09/06      500       8501         5/08/06        500     4843
           6/21/06    7,000       8501         6/20/06      7,000     4843
           7/03/06    4,000       4843         7/03/06      4,000     8501
           7/13/06    3,000       8501         7/12/06      3,000     4843
           7/27/06    1,000       4843         7/28/06      1,000     8501
           8/22/06    2,000       4843         8/22/06      2,000     8501
           8/29/06    5,000       4843         8/28/06      5,000     8501
           9/20/06    9,000       9897         9/20/06      9,000     4843
           9/25/06    3,000       9897         9/25/06      3,000     4843
           9/27/06    2,000       9897         9/27/06      2,000     4843
           9/28/06    1,000       9897         9/28/06      1,000     4843
           9/29/06    4,500       9897         9/29/06      4,500     4843
           10/24/06   1,000       9897         10/24/06     1,000     4843
           11/07/06   5,500       4843         11/07/06     5,500     9897
           11/20/06   4,000       4843         11/20/06     4,000     9897
           11/27/06   2,000       9897         11/27/06     2,000     4843
           11/30/06 20,000        4843         11/30/06    20,000     9897
           12/11/06   1,500       4843         12/11/06     1,500     9897
           12/15/06   3,500       9897         12/14/06     3,500     4843
            Total   $88,500                               $88,500

       Petitioners’ 2007 bank statements for accounts ending in 4843 and 9897

show the same type of activity.4 The relevant transactions are summarized below:


       4
       We note that 2007 bank statements for the account ending in 6236, which
was identified in the parties’ stipulation of facts, were not submitted into evidence.
We further note that for 2005, only bank account statements for the account
ending in 4843 were submitted. Thus, we could not make similar findings of
                                       -9-

[*9]

               Withdrawal                             Deposit
           Date Amount Account                 Date   Amount Account
         1/18/07     $500       9897         1/18/07    $500     4843
         2/02/07      500       9897         2/02/07      500    4843
         2/06/07    1,500       9897         2/06/07    1,500    4843
         3/05/07    1,000       9897         3/05/07    1,000    4843
         5/09/07    2,000       9897         5/09/07    2,000    4843
         5/25/07      600       9897         5/25/07      600    4843
         5/30/07      500       9897         5/30/07      500    4843
         6/08/07    3,000       4843         6/08/07    3,000    9897
         6/11/07    5,000       4843         6/11/07    5,000    9897
         6/25/07    1,500       9897         6/25/07    1,500    4843
         7/02/07      500       9897         7/02/07      500    4843
         7/16/07      500       9897         7/16/07      500    4843
         8/03/07    1,000       9897         8/03/07    1,000    4843
         9/11/07   12,000       4843         9/11/07 12,000      9897
         9/21/07      700       4843         9/21/07      700    9897
         10/29/07     500       9897         10/29/07     500    4843
         11/07/07   1,000       9897         11/07/07 1,000      4843
         11/16/07   1,000       4843         11/16/07 1,000      9897
         12/12/07   1,000       4843         12/12/07 1,000      9897
         12/13/07   1,000       4843         12/13/07 1,000      9897
          Total   $35,300                             $35,300

III.   Check from AFC of Cal., LLC--San Francisco

       On December 5, 2007, AFC of Cal., LLC--San Francisco (AFC) issued

Manteca Quality Auto Sales a check for $10,000. A copy of the check, with a




corresponding deposits and withdrawals for 2005.
                                       - 10 -

[*10] handwritten note stating “Get loan on Pacifica” immediately below the

check image, was submitted into evidence. In addition, petitioners’ bank account

statement for the account ending in 9897 shows that a $10,000 deposit was made

the same day.

                                     OPINION

I.    Petitioners’ unreported income

      A.     Legal standard

      Gross income includes all income from whatever source derived, unless

otherwise specifically excluded. Sec. 61(a). The definition of gross income

broadly includes any instance of undeniable accessions to wealth, clearly realized,

and over which the taxpayer has complete dominion and control. Commissioner v.

Glenshaw Glass Co., 348 U.S. 426, 431 (1955).

      In the Court of Appeals for the Ninth Circuit, to which this case is

appealable absent the parties’ stipulation otherwise, see sec. 7482(b)(1)(A), the

Commissioner’s determinations as to unreported income in a notice of deficiency

are presumed correct only when they are supported by a minimal evidentiary

foundation, Weimerskirch v. Commissioner, 596 F.2d 358, 360-361 (9th Cir.

1979), rev’g 67 T.C. 672 (1977); see also Delaney v. Commissioner, 743 F.2d 670,

671 (9th Cir. 1984) (stating that the Commissioner must produce some substantive
                                       - 11 -

[*11] evidence demonstrating that the taxpayer received unreported income), aff’g

T.C. Memo. 1982-666. Once the Commissioner meets his burden of production,

“the taxpayer must establish by a preponderance of the evidence that the

determination is arbitrary or erroneous.” Delaney, 743 F.2d at 671; United States

v. Stonehill, 702 F.2d 1288, 1294 (9th Cir. 1983).

      Where the taxpayer has failed to maintain adequate records as required by

section 6001, the Commissioner is authorized to reconstruct the taxpayer’s income

by any reasonable method that clearly reflects income, including the bank deposits

method. See Holland v. United States, 348 U.S. 121, 132-133 (1954); United

States v. Hall, 650 F.2d 994, 996 n.4 (9th Cir. 1981) (“The bank deposits method

of proof is * * * a circumstantial way of establishing unreported income.”). Under

the bank deposits method, the Commissioner must show that the taxpayer was

engaged in income-producing activities, that he made regular deposits of funds

into his bank accounts, and that an adequate and full investigation of those

accounts was conducted to distinguish taxable income from nontaxable deposits.

United States v. Stone, 770 F.2d 842, 844 (9th Cir. 1985). “The critical question

is whether the government’s investigation has provided sufficient evidence to

support an inference that an unexplained excess in bank deposits is attributable to

taxable income.” Id. at 844-845. When using the bank deposits method, the
                                       - 12 -

[*12] Commissioner assumes a special responsibility of being thorough and

particular in his investigation and presentation. Hall, 650 F.2d at 999 (citing

Holland, 348 U.S. at 135-136).

      B.     Unreported gross receipts or sales

      We find that respondent has met his evidentiary burden to establish that

petitioners had unreported income. Petitioners operated a car sales business in

2006 and 2007 and made regular deposits into their bank accounts. Furthermore,

Agent Lion distinguished taxable income from nontaxable deposits when he

subtracted electronic transfers, refunded checks, returned purchases, returned bank

fees, sales tax deposits, and rent deposits from gross deposits. According to his

analysis, Agent Lion determined that petitioners underreported their gross sales by

$243,184 for 2006 and $73,307 for 2007.

      We further conclude, however, that petitioners have established by a

preponderance of the evidence that respondent’s determination is erroneous as to

some portions of their 2006 and 2007 income. Petitioners argue that the gross

sales that Agent Lion determined should be further reduced by funds transferred

between petitioners’ bank accounts via cash or check. We agree.

      Petitioners argue that Agent Lion double counted some income by not

excluding interaccount cash and check transfers. Petitioners’ bank account
                                       - 13 -

[*13] statements reflect a number of transactions which they have shown by a

preponderance of the evidence to be interaccount transfers. The rounded amounts

of the deposits and the temporal proximity of corresponding withdrawals in

identical amounts from one of petitioners’ other bank accounts lead us to conclude

that these deposits were transfers rather than sales proceeds. At trial Agent Lion

testified that he subtracted from gross deposits all amounts which the bank

identified as transfers. However, petitioners’ bank account statements did not

identify transfers made via cash or check as transfers. In addition, Agent Lion’s

2006 and 2007 bank deposits analyses did not identify these deposits as transfers.

Consequently, we find that $88,500 in 2006 and $35,300 in 2007 are nontaxable

deposits.

      Petitioners further argue that a bank deposit of $10,000 was proceeds from

an AFC loan and thus is not taxable income. Respondent does not dispute that

loan proceeds are not taxable income but argues instead that petitioners have

failed to identify any evidence of the alleged loan. The record shows that AFC

issued a check to petitioners for $10,000 which was deposited in petitioners’ bank

account ending in 9897 that same day. The record further shows that a copy of the

check was maintained with a handwritten note describing the funds as a loan for a

Chrysler Pacifica. Thus, petitioners’ sole evidence that the $10,000 deposit was a
                                        - 14 -

[*14] loan rather than sales proceeds is a handwritten note, which may or may not

have been written in preparation for trial. Given the lack of supporting loan

documentation, we find the handwritten note unreliable. Petitioners have failed to

show that the $10,000 check from AFC was a nontaxable loan.

II.   Abandoned issues

      A.     Issues addressed by respondent but not addressed by petitioners

      Respondent submitted a number of issues for decision, which petitioners

have not addressed. They are as follows: (1) whether petitioners are entitled to

deduct advertising expenses for 2007 in excess of what respondent allowed; (2)

whether petitioners are entitled to deduct other expenses for 2007 in excess of

what respondent allowed; (3) whether petitioners are entitled to deduct taxes and

licenses expenses for 2006 and 2007 in excess of what respondent allowed; (4)

whether petitioners are entitled to costs of goods sold for 2005, 2006,5 and 2007 in

excess of what respondent allowed; and (5) whether petitioners are liable for the

section 6651(a)(1) addition to tax for 2005. As to the first four issues,

respondent’s determinations are presumed correct and petitioners bear the burden


      5
       At trial petitioners submitted a number of receipts for car purchases made
in 2006. These receipts total $504,391.61. We note that this is substantially less
than the $1,171,665 costs of goods sold deduction that respondent has already
allowed.
                                        - 15 -

[*15] of proving otherwise. See Rule 142(a); Welch v. Helvering, 290 U.S. 111,

115 (1933); see also INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992)

(“‘[A]n income tax deduction is a matter of legislative grace and * * * the burden

of clearly showing the right to the claimed deduction is on the taxpayer[.]’”)

(quoting Interstate Transit Lines v. Commissioner, 319 U.S. 590, 593 (1943)). As

to the fifth issue, respondent has satisfied his burden, see sec. 7491(c), by

producing evidence that petitioners filed their 2005 return nearly a year late.

Consequently, and because petitioners have not advanced any argument in brief as

to the foregoing issues, we sustain respondent’s determinations. See Mendes v.

Commissioner, 121 T.C. 308, 313-314 (2003) (holding that arguments not

addressed in brief may be considered abandoned).

      B.     Issues not addressed by either party

      Petitioners raised a number of issues at trial which neither party has

addressed in posttrial briefs. These include: (1) whether Agent Lion failed to

subtract from petitioners’ 2006 income refunds of $25,506 and $1,900 that

petitioners made to customers; (2) whether petitioners are entitled to a deduction

for $24,065 of car loan repayments made to Finance & Thrift; (3) whether

petitioners are entitled to deductions for payments of $56,805 and $56,891 made

on car loans that petitioners assumed upon acquisition; and (4) whether certain
                                          - 16 -

[*16] (unspecified) deposits were nontaxable loans from friends and family. Since

neither party has addressed these issues in brief, we deem them abandoned. See

Nicklaus v. Commissioner, 117 T.C. 117, 120 n.4 (2001) (holding that arguments

asserted before filing briefs, but not advanced in brief, are considered abandoned).

Further, even if we did not deem these issues to be abandoned, petitioners have

failed to carry their burden of proving that respondent’s determinations are in

error.

III.     Accuracy-related penalties

         Petitioners concede that they are liable for the section 6662(a) penalty for

2007 because they were negligent. See sec. 6662(b)(1). Petitioners argue,

however, that they are not liable for section 6662(a) penalties for 2005 and 2006

because they were not negligent in those years. Moreover, petitioners claim that it

is respondent who was negligent in conducting petitioners’ audits.

         A.    Respondent’s prima facie case

         Under section 7491(c), the Commissioner bears the burden of production

with regard to penalties and must come forth with sufficient evidence to show that

imposition of the penalty is appropriate. Higbee v. Commissioner, 116 T.C. 438,

446 (2001). Respondent argues that the section 6662(a) penalty applies because

petitioners had been negligent and because petitioners substantially understated
                                       - 17 -

[*17] their income tax. See sec. 6662(b)(1) and (2). Only one accuracy-related

penalty may be imposed for a given portion of an underpayment even where that

portion implicates more than one form of misconduct. Sec. 1.6662-2(c), Income

Tax Regs. Respondent will have met his burden of production if Rule 155

computations show that petitioners had a substantial understatement of income

tax. See, e.g., Jarman v. Commissioner, T.C. Memo. 2010-285, 100 T.C.M.

(CCH) 599, 602 (2010); Prince v. Commissioner, T.C. Memo. 2003-247, 86

T.C.M. (CCH) 283, 288 (2003). Section 6662(d)(1) defines a substantial

understatement as one which exceeds the greater of 10% of the taxpayer’s correct

liability or $5,000. We further find that petitioners were negligent under section

6662(b)(1) because they failed to keep adequate books and records regarding their

auction activities and because they failed to substantiate expenses properly. Sec.

1.6662-3(b)(1), Income Tax Regs.

      B.     Reasonable cause under section 6664(c)(1)

      Petitioners further argue that the section 6662(a) penalty does not apply

because they acted with reasonable cause and in good faith. Once the

Commissioner has met the burden of production, the burden shifts to the taxpayer

to prove that the Commissioner’s determination is incorrect. Higbee v.

Commissioner, 116 T.C. at 446-447. An accuracy-related penalty may not be
                                          - 18 -

[*18] imposed where the taxpayer has acted with reasonable cause and in good

faith. Sec. 6664(c)(1); Higbee v. Commissioner, 116 T.C. at 448. Whether the

taxpayer acted with reasonable cause and in good faith depends upon all the

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

taxpayer’s reliance on the advice of a professional, such as a C.P.A., may

constitute reasonable cause and good faith if the taxpayer could prove by a

preponderance of the evidence that: (1) the taxpayer reasonably believed the

professional was a competent tax adviser with sufficient expertise to justify

reliance; (2) the taxpayer provided necessary and accurate information to the

advising professional; (3) the taxpayer actually relied in good faith on the

professional’s advice. Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43,

99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002); see also sec. 1.6664-4(c)(1), Income

Tax Regs. (“[T]he taxpayer’s education, sophistication and business experience

will be relevant in determining whether the taxpayer’s reliance on tax advice was

reasonable and made in good faith.”)

      We find that petitioners have established reasonable cause and good faith as

to $3,0006 of unreported gross receipts for 2005, which resulted from a slight


      6
          Petitioners have stipulated this $3,000 of additional sales. See supra note
2.
                                         - 19 -

[*19] discrepancy between petitioners’ Federal tax return and State sales tax

return.7 Mr. Fakhouri, a professional C.P.A. with over 40 years of experience,

calculated petitioners’ 2005 gross sales using their State sales tax returns, which

he testified were “absolutely accurate”. Consequently, and in the light of Mr.

Pawar’s limited education, we find that their reliance on Mr. Fakhouri’s advice as

to this $3,000 was justified.

      Petitioners, however, have not established that they acted with reasonable

cause and in good faith with regard to their 2006 understatement of gross sales.

Petitioners admit that they purchased and sold cars at auction but failed to keep

any records and thus never provided them to Mr. Fakhouri. In fact, the record is

unclear as to whether before the audits Mr. Fakhouri was even aware of

petitioners’ auction activities. Despite Mr. Pawar’s limited education, we find that

petitioners did not act with reasonable cause and in good faith in failing to

maintain records of their auction sales, especially in the light of the fact that Ms.

Pawar successfully maintained the requisite records for sales made through their

dealership.




      7
      Respondent did not place into issue whether petitioners had unreported
income from their 2005 auction activities.
                                        - 20 -

[*20] Finally, petitioners have not established reasonable cause and good faith

with regard to their 2005 and 2006 cancellation of debt income, see supra note 2,

because they failed to submit any credible substantiating evidence.

         In reaching our holdings, we have considered all arguments made, and, to

the extent not mentioned above, we conclude they are moot, irrelevant, or without

merit.

         To reflect the foregoing,


                                                 Decision will be entered under Rule

                                        155.
