                          T.C. Memo. 1998-206



                        UNITED STATES TAX COURT



   DARRYL SHAWN AND MELONEE YEVETTE BUNDRIDGE, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



        Docket No. 20355-95.                    Filed June 15, 1998.



        Darryl Shawn Bundridge, pro se.

        Lisa Kuo, for respondent.



                MEMORANDUM FINDINGS OF FACT AND OPINION

     WRIGHT, Judge:     Respondent determined a deficiency of $4,976

and an accuracy-related penalty of $995 in petitioners' Federal

income tax for 1992, and a deficiency of $8,355 and an accuracy-

related penalty of $1,671 in petitioners' Federal income tax for

1993.
                                 - 2 -


     The parties have agreed to certain adjustments for the

taxable years 1992 and 1993.    The following issues remain for

decision:

     (1)    Whether petitioners are entitled to deduct rental

expenses for 1992 in excess of those conceded by respondent.

     (2)    Whether petitioners are entitled to deduct mileage

expenses for 1992 and 1993 in excess of those conceded by

respondent.

     (3)    Whether petitioners' cost of goods sold for 1993 for

their business of Hi Fidelity Record was correctly reported on

Schedule C of their amended Federal income tax return.

     (4)    Whether the markup percentage used by respondent for

the goods sold was correct in determining petitioners' gross

receipts for 1992 and 1993.

     (5)    Whether petitioners are liable for the accuracy-related

penalties under section 6662(a)1 for 1992 and 1993.

                          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.    Petitioners resided in Rialto, California,

when their petition was filed.


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


     Petitioners were married during 1992 and 1993.     They were

divorced in 1996.    During 1992 and 1993, petitioner Darryl

Bundridge worked full time as a Los Angeles Police Officer.

During 1991 and 1993, petitioner Melonee Bundridge worked at

Atchison Topeka & Santa Fe Railway.

     In 1989, petitioners started their Schedule C business,

known as Hi Fidelity Record (also known as High Fidelity

Records).    Hi Fidelity Record sold records, cassette singles,

cassettes, compact discs, batteries, and blank cassette tapes in

the retail market in Rialto, California.    As of January 1992,

petitioners operated the business out of rented space from Hub

Properties.    Later, on April 29, 1992, they relocated to Rialto

Discount Mall.

     Petitioners bought their supply of records, cassettes, and

compact discs from Abbey Road Distributors (Abbey Road), which

was located in Los Angeles, California.    Petitioners made these

purchases at Abbey Road's pickup counter in Los Angeles and paid

for them mainly in cash.

     Petitioners filed a U.S. Individual Income Tax Return, Form

1040, for the taxable year 1992.    On Schedule C, Profit or Loss

From Business, of their 1992 return, petitioners reported the

following in regard to Hi Fidelity Record:

            Gross Receipts:                    $6,100

            Expenses:
                 Advertising                      125
                               - 4 -


               Car and truck                    none
               Insurance                         125
               Office expense                     75
               Other business property rent   16,000
               Repairs and maintenance         2,441
               Supplies                        1,200
               Tax and licenses                  263
               Utilities                         851
               Business phone                    950
               Water                             200
               Page phone                        100
               Alarm                             305


In the notice of deficiency, respondent disallowed all expenses

claimed on the Schedule C for 1992.

     Petitioners filed a U.S. Individual Income Tax Return, Form

1040, for the taxable year 1993.   They filed an Amended U.S.

Individual Income Tax Return, Form 1040X, for the taxable year

1993, stating that Schedule C had been changed due to an inter-

office bookkeeping audit.   On Schedule C of their 1993 return and

their amended 1993 return, petitioners reported the following for

Hi Fidelity Record:

                                         Original       Amended
                                         Return         Return

     Gross Receipts:                     $17,439        $102,000

     Expenses, which included:
          Advertising                       none           1,000
          Car and truck                    5,600           5,600
          Insurance                         none           2,200
          Office expense                      84             184
          Other business property rent    11,352          11,352
          Repairs and maintenance           none            none
          Supplies                        10,500          61,250
          Tax and licenses                   154            none
          Utilities                         none           5,000
          Business phone                     687            none
                               - 5 -


           Water                            none              none
           Page phone                       none              none
           Alarm                            none              none

In the notice of deficiency, respondent disallowed all expenses

claimed on the Schedule C for the taxable year 1993.

     Petitioners' 1992 and 1993 Federal income tax returns were

prepared by Bernadette Henderson of Green's Tax Service, and

their amended 1993 return was prepared by Lee Green of Green's

Tax Service.

     At the end of the trial, respondent orally moved for leave

to conform the pleadings to the evidence under Rule 41(b).

Petitioners did not object.   We took the motion under advisement.

                              OPINION

     As a preliminary matter, we consider whether respondent's

motion to conform the pleadings to the evidence should be

granted.

     Respondent's motion is for leave to file an amended answer

for an increased deficiency and penalty.   The deficiency for 1992

would be increased from $4,976 to $5,846 resulting from the

correction of the gross receipts to $48,677 and the cost of goods

sold to $29,236.2   The penalty for 1992 would be increased from

$995 to $1,169.


     2
        On their 1992 Schedule C, petitioners claimed $1,200 as
the amount of supplies. The parties agreed that the goods
purchased (cost of goods sold) for 1992 was $29,236. This was
based on the total purchases from Abbey Road.
                                  - 6 -


     Respondent moved pursuant to Rule 41(b) to increase the

deficiency.   See sec. 6214(a).    Rule 41(b)(1) provides that

     Issues Tried by Consent: When issues not raised by the
     pleadings are tried by express or implied consent of the
     parties, they shall be treated in all respects as if they
     had been raised in the pleadings. The Court, upon motion of
     any party at any time, may allow such amendment of the
     pleadings as may be necessary to cause them to conform to
     the evidence and to raise these issues, but failure to amend
     does not affect the result of the trial of these issues.

Whether a motion seeking an amendment should be allowed is within

the sound discretion of the Court.        Commissioner v. Estate of

Long, 304 F.2d 136 (9th Cir. 1962).       If there is unfair surprise

or prejudice to the opposing party, then the motion to amend

should be denied.

     We do not find that granting respondent's motion to amend

would result in unfair surprise to petitioners.       In the notice of

deficiency, respondent listed an adjustment for "Gross Receipts

Sch. C." for 1992 and 1993, but respondent did not state a dollar

adjustment.   On the schedule B of the notice of deficiency, the

explanation for this adjustment stated that "[t]his issue has

been opened for examination and can still be audited."

     Petitioners did not object to respondent's oral motion to

conform the pleadings to the evidence.       Further, evidence

necessary to decide the issue of the additional deficiencies was

presented at trial.   Petitioners did not object to testimony

regarding this matter and even questioned the witnesses about it.

Petitioners' pretrial memorandum included the following issues
                                  - 7 -


for trial:    (1) Inventory markup percentage for 1992; (2) the

amount of inventory unsold at the end of 1992; and (3) gross

income for 1992.     In view of petitioners' actions, we find that

the issues were tried with their implied consent.

     Accordingly, we will grant respondent's motion to amend his

answer to conform to the evidence so as to assert an increased

deficiency and penalty for 1992.      Respondent has the burden of

proving, however, that petitioners are liable for the increased

deficiency and penalty.    Rule 142(a).




Issue 1.    Rental Expenses

     Deductions are matters of legislative grace, and "only as

there is clear provision therefor can any particular deduction be

allowed."    New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440

(1934).

     Section 162(a) provides in part that

          SEC. 162(a). In General.--There shall be allowed as a
     deduction all the ordinary and necessary expenses paid or
     incurred during the taxable year in carrying on any trade or
     business, including--

                 *     *      *   *       *   *   *

                 (3) rentals or other payments required to be made
            as a condition to the continued use or possession, for
            purposes of the trade or business, of property to which
            the taxpayer has not taken or is not taking title or in
            which he has no equity.
                                   - 8 -


     In 1992, petitioners claimed a deduction for rental expenses

in the amount of $16,000.    Respondent has agreed that petitioners

were entitled to deduct $8,374 of the $16,000 claimed deduction.

Respondent estimated the monthly rental payment to Hub Properties

to be $1,350 on the basis of the prior lease contract adjusted

for an estimated increase.    Petitioners presented no

substantiation to reflect the actual payments to Hub Properties.

Respondent allowed 3 months (January to March of 1992) of rental

expenses paid to Hub Properties but disallowed any allowance for

April.    On April 29, 1992, petitioners relocated to Rialto

Discount Mall, renting space from April 29 through December 31,

1992.    Respondent allowed 6 months of rent based on the amounts

substantiated by checks.    The following summarizes respondent's

computations:

     Hub Properties:     January           1992   $1,350
     (no substantiation) February          1992    1,350
                         March             1992    1,350
                         April             1992     -0-
                                                    1
     Rialto Discount        Checks of                952
       Mall                                          728
                                                     728
                                                     728
                                                     800
                                                     388
         Rental expenses allowed                  $8,374
     1
       The full amount of the check was $1,680, but $728 of the
payment was the security deposit.

     Petitioners argue that respondent should have allowed the

April payment to Hub Properties and the missing two monthly
                                   - 9 -


payments to Rialto Discount Mall.      For the months disallowed,

petitioners provided no documentary evidence that the claimed

expenses were paid and provided no other evidence to corroborate

their claim.       Therefore, we conclude that petitioners failed to

substantiate that the claimed expenses were paid or incurred.

Thus, petitioners are not entitled to rental expenses in excess

of those allowed by respondent in 1992.

Issue 2.       Mileage Expenses

       Section 162(a) allows a deduction for all the ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on any trade or business, including traveling expenses

while "away from home" in the pursuit of a trade or business.          A

deduction for transportation expenses is also allowed for local

travel from one business location to another.          Secs. 162(a)(2),

274.       Both traveling expenses and transportation expenses are

subject to the substantiation requirements of section 274(d),

which provides in part that

            SEC. 274(d). Substantiation Required.--No deduction or
       credit shall be allowed--

               (1) under section 162 or 212 for any traveling expense
            (including meals and lodging while away from home),

                    *    *    *    *       *   *   *

               (4) with respect to any listed property (as defined in
           section 280F(d)(4)[3]),

       3
            Sec. 280F(d)(4)(A)(i) provides that listed property means
                                                       (continued...)
                              - 10 -


     unless the taxpayer substantiates by adequate records or by
     sufficient evidence corroborating the taxpayer's own
     statement (A) the amount of such expense or other item, (B)
     the time and place of the travel * * *, (C) the business
     purpose of the expense or other item, and (D) the business
     relationship to the taxpayer of persons entertained, using
     the facility or property, or receiving the gift. * * *

     In 1992, petitioners did not claim a deduction for car and

truck expenses on their Schedule C.    Respondent has agreed that

petitioners were entitled to deduct $1,680 for car and truck

expenses in that year.   In 1993, petitioners claimed a deduction

for car and truck expenses in the amount of $5,600.      They also

claimed the same $5,600 on their amended 1993 return.      Respondent

has agreed that petitioners were entitled to $1,680 of the $5,600

claimed for car and truck expenses in 1993.

     In allowing $1,680 for car and truck expenses in both 1992

and 1993, the revenue agent based his conclusion on the number of

trips from Rialto, California, to Abbey Road in Los Angeles,

California.   The agent testified that petitioners originally

approximated that one trip per week was taken.   After securing

invoices from Abbey Road, which totaled 183 in 1992 and 188 in

1993,4 the agent estimated that two trips were taken per week,

for a total of 100 trips per year.




     3
      (...continued)
any passenger automobile.
     4
         For 1993, 2½ months of invoices were missing.
                                - 11 -


     Petitioners argue that the deduction for car and truck

mileage should be based on 183 trips in 1992 and 188 trips in

1993, because of the number of invoices.    They point to the

testimony of Mr. Ginsburg, the custodian of records at Abbey

Road, who stated that the invoices contained language that the

merchandise was purchased and picked up in Los Angeles.    However,

petitioners did not provide any evidence (such as a diary or log)

to corroborate the number of trips that occurred.

     Petitioners did not maintain any records (such as an account

book, diary, log, or trip sheets) to substantiate the claimed

mileage expense deductions.    Petitioners failed to substantiate

the mileage expenses by adequate records.    Sec. 1.274-

5T(c)(2)(i), Temporary Income Tax Regs., 50 Fed. Reg. 46017 (Nov.

6, 1985).   They also failed to substantiate the mileage expenses

by other sufficient evidence.    Sec. 1.274-5T(c)(3)(i), Temporary

Income Tax Regs., 50 Fed. Reg. 46020 (Nov. 6, 1985).

Consequently, petitioners are not entitled to the claimed car and

truck expenses in excess of the $1,680 in 1992 and the $1,680 in

1993 conceded by respondent.



Issue 3.    Cost of Goods Sold (Supplies)

     Cost of goods sold is subtracted from gross receipts from

sales to determine gross income from sales.    Sec. 1.61-3(a),

Income Tax Regs.    The cost of goods purchased for resale is
                               - 12 -


determined by making proper adjustments for opening and closing

inventory and purchases.   Sec. 1.162-1(a), Income Tax Regs.

     Petitioners did not determine their cost of goods sold for

1992 and 1993.   Instead, they listed purchases from Abbey Road as

the deductible expense "supplies".      Respondent concedes that

petitioners are entitled to cost of goods sold equal to the

amount of goods purchased during the year.

     For 1993, petitioners and respondent do not agree on the

amount of goods purchased.   On petitioners' 1993 Schedule C, they

claimed supplies of $10,500, and on their 1993 amended Schedule

C, they claimed supplies of $61,250.      Petitioners now contend

that the cost of goods sold for 1993 was less than $61,250.

Respondent concedes that petitioners are entitled to cost of

goods sold of $61,250 in 1993.   We sustain respondent's allowance

of cost of goods sold in 1993 of $61,250, as claimed by

petitioners in their amended 1993 return.

Issue 4.   Markup Percentage and Gross Receipts

     Taxpayers are required to maintain records, including the

documentation of transactions, expenses, etc.      Sec. 6001.   It is

well established that if a taxpayer's records are inadequate to

permit a verification of the returns or if the records are

unreliable, the Commissioner may determine the taxpayer's taxable

income by other reasonable means, including the percentage markup

method.    See Bollella v. Commissioner, 374 F.2d 96 (6th Cir.
                              - 13 -


1967), affg. T.C. Memo. 1965-162; Bernstein v. Commissioner, 267

F.2d 879 (5th Cir. 1959), affg. T.C. Memo. 1956-260; Kurnick v.

Commissioner, 232 F.2d 678 (6th Cir. 1956), affg. per curiam T.C.

Memo. 1955-31; Stone v. Commissioner, 22 T.C. 893 (1954).     Under

the percentage markup method, gross receipts are determined by

adding a percentage to the cost of goods sold.   The burden of

proof is on petitioners to show that respondent's method does not

clearly reflect income.   Rule 142(a); see sec. 446.

     Since petitioners did not keep books to show gross receipts

from sales, it was permissible for respondent to apply a markup

percentage to determine their gross receipts for 1992 and 1993.

     In 1992, on their Schedule C, petitioners claimed supplies

of $1,200 and stated gross receipts of $6,100 (a markup of over

500 percent).   Later, petitioners and respondent agreed that the

amount of purchases (cost of goods sold) was $29,236.   On the

basis of the cost of goods sold, respondent asserted that

petitioners had gross receipts in 1992 of $48,677 (using the

markup of 66.5 percent reflected on petitioners' amended 1993

return).

     In 1993, on their Schedule C, petitioners listed gross

receipts of $17,439 (a markup of 66.1 percent), and in their

amended return, they listed gross receipts of $102,000 (a markup

of 66.5 percent).   As noted above, respondent conceded that the

cost of goods sold in 1993 was $61,250.   On the basis of the cost
                                 - 14 -


of goods sold, respondent asserted that petitioners had gross

receipts in 1993 of $102,000, as stated in the 1993 amended

return (a markup of 66.5 percent).

     Petitioners argue that respondent's markup percentage is

excessive.    They assert that the sale price and markup percentage

were as follows:

                           Sale Price        Markup Percentage

     Compact discs          $11.99                     15%
     Cassettes                7.99                     15%
     Cassette singles         2.49                     25%
     Records                  4.99                     25%

       Overall average                                 20%

In support of this, petitioners point to Mr. Ginsburg's testimony

regarding the typical sale price of music products.          He stated

that the typical list prices for "release products on sale" were:

                 Compact discs          $11.99/12.99
                 Cassettes              $7.98/8.98

     In evaluating petitioners' conclusion that the overall

markup percentage is 20 percent, we begin with their asserted

sale price.    Petitioners attempted to establish their sale price

by Mr. Ginsburg's testimony regarding the typical price for

release products on sale, and by receipts from Target,

Blockbuster Music, and Circuit City.      However, Mr. Ginsburg

stated he had no knowledge of what petitioners were actually

selling their products for, and petitioners presented no evidence

regarding the prices they sold the products for.         We are not

persuaded of the accuracy of petitioners' stated sale prices.            We
                                - 15 -


find the "list price" set by the music industry (as stated in the

invoices from Abbey Road) to be a more accurate reflection of

petitioners' sale prices.     The invoices provide the following

list prices for the purchases made by petitioners:

                                   List Prices

           Batteries                  $2.39
                                       4.09
                                       6.09

           Cleaning kits                 2.89

           Blank cassette tapes          2.79
                                         2.99

           Cassette singles              3.49

           Maxicassette                  5.98

           Records                       5.98

           Cassettes                   4.98
                                       5.98
                                       6.49
                                       6.98
                                       7.98
                                       8.98
                                       9.98
                                      10.98
                                      12.98

           Compact discs              13.99
                                      14.99
                                      15.99
                                      16.99

     Next, we evaluate the markup percentage.     Petitioners

contend that there was a constant markup percentage for each

item:   15 percent for compact discs, 15 percent for cassette

singles, 25 percent for cassette singles, and 25 percent for

records.   While petitioners suggest constant purchase prices,
                               - 16 -


petitioners in fact purchased the goods with varying list prices

at varying costs.   Examining a sample of the invoices from 1992

and 1993, the markup percentage varied for each product as

follows:

                                     Markup percentage

            Batteries                      54-63%
            Cleaning kits                    70%
            Blank cassette tapes           66-72%
            Records                          55%
            Cassette singles                 75%
            Maxicassette                   55-94%
            Cassettes                      53-92%
            Compact discs                  36-66%

     The markup percentage of 66.5 percent used by respondent in

both 1992 and 1993 is consistent with the sample invoices we

examined.    Petitioners have not shown that the markup percentage

was otherwise.    Thus, we find that petitioners have failed to

meet their burden of proof in regard to 1993, and that respondent

has met his burden for the increased deficiency in 1992.    We hold

that petitioners had gross receipts of $48,677 in 1992 and

$102,000 in 1993.

Issue 5.    Section 6662(a) Accuracy-Related Penalties

     Respondent determined that petitioners are liable for

accuracy-related penalties for 1992 and 1993 under section

6662(a) because the underpayments of income tax for those years

were attributable to negligence.    Petitioners contend that they

are not liable for the accuracy-related penalties for either

year.
                               - 17 -


     Section 6662 imposes a penalty equal to 20 percent of the

part of the underpayment of tax that is attributable to

negligence.   Sec. 6662(a) and (b)(1).   For purposes of section

6662, negligence is a failure to reasonably attempt to comply

with the provisions of the Internal Revenue Code.    Sec. 6662(c).

Negligence is defined as "'lack of due care or failure to do what

a reasonable and ordinarily prudent person would do under the

circumstance.'"    Neely v. Commissioner, 85 T.C. 934, 947 (1985)

(quoting Marcello v. Commissioner, 380 F.2d 499, 506 (5th Cir.

1967)).    A taxpayer has the burden of proving that the

Commissioner's determination of an addition to tax is in error.

Luman v. Commissioner, 79 T.C. 846, 860-861 (1982).

     The accuracy-related penalty under section 6662(a) does not

apply to any part of an underpayment if the taxpayer shows that

there is reasonable cause for that part of the underpayment and

that the taxpayer acted in good faith based on the facts and

circumstances.    Sec. 6664(c)(1).

     In petitioners' closing statement and posttrial brief, they

argue that they are not liable for the penalties because of their

reasonable and good faith efforts, citing Lyons v. Commissioner,

T.C. Memo. 1991-84.    In Lyons, the taxpayers had a reasonable

system for maintaining financial records and preparing their tax

returns.   In addition, the taxpayers had a relationship with an

accountant who prepared their returns.    While many of the

relevant records were unavailable to the taxpayers, the Court
                              - 18 -


noted that many of the records were relinquished in a bankruptcy

proceeding and some of the records were not recovered from their

accountant.   The Court determined that the taxpayers were not

liable for the negligence penalty.

     Petitioners argue that they "made repeated attempts to

retrieve all records and receipts from their accountant, who died

Dec. 1996."   Petitioners' 1992 and 1993 returns were prepared by

Bernadette Henderson of Green's Tax Service, and petitioners'

amended 1993 return was prepared by Lee Green of Green's Tax

Service.   Petitioners did not testify on their own behalf to

describe the circumstances in regard to the preparation of the

returns, and they did not call anyone involved with Green's Tax

Service.   Instead, in closing arguments, Mr. Bundridge described

their reliance on their accountant Lee Green.   However, there is

no evidence in the record to support petitioners' conclusion that

their good faith reliance on the accountant constituted

reasonable cause.   Therefore, we sustain respondent's

determinations with respect to the penalties for 1992 and 1993.

     To reflect the foregoing,

                                          An order will be issued

                                     granting respondent's motion,

                                     and a decision will be entered

                                     under Rule 155.
