                     T.C. Summary Opinion 2009-117



                        UNITED STATES TAX COURT



              RAO V. AND SUNANDA MADDURI, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



        Docket No. 4798-08S.            Filed July 27, 2009.



        Rao V. and Sunanda Madduri, pro sese.

        Matthew A. Mendizabal, for respondent.



     DEAN, Special Trial Judge:     This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect when the petition was filed.    Pursuant to section 7463(b),

the decision to be entered is not reviewable by any other court,

and this opinion shall not be treated as precedent for any other

case.     Unless otherwise indicated, subsequent section references

are to the Internal Revenue Code in effect for the year in issue,
                                - 2 -

and all Rule references are to the Tax Court Rules of Practice

and Procedure.

     Respondent determined a $27,874 deficiency in petitioners’

2005 Federal income tax and an accuracy-related penalty under

section 6662(a).1

     In a stipulation of settled issues, respondent and Mr.

Madduri agreed that Mr. Madduri received $88,433 from Outer Bay

Technologies, Inc. (Outer Bay), as compensation for services that

should have been reported on “line 7 of petitioners’ Form 1040”

rather than on “line 1 of petitioners’ Schedule C”.    Respondent

did not assert a claim under section 6214(a) for the increased

deficiency that will result from the disallowance of petitioners’

claimed deductions for section 179 expenses and section 280A

expenses for the business use of their home pursuant to sections

179(b)(3)(A) and 280A(c)(5).    Petitioners did not contest

respondent’s position, which respondent argued at trial and which

was set out in respondent’s pretrial memorandum.    The Court,

therefore, considers the issues tried by consent under Rule

41(b).   Respondent has met his burden of proving that petitioners

are not entitled to deduct those expenses on their Schedule C,

Profit or Loss From Business.    See Rule 142(a); see also secs.


     1
      Sunanda Madduri (Mrs. Madduri) did not appear at trial or
sign the stipulation of facts. The Court will dismiss Mrs.
Madduri for failure properly to prosecute and will enter a
decision against her consistent with the decision entered against
Rao V. Madduri (Mr. Madduri).
                                - 3 -

179(b)(3)(A), 280A(c)(5).   In addition, Mr. Madduri did not

assert that petitioners are otherwise entitled to deduct any

portion of those expenditures as unreimbursed employee expenses

on their Schedule A, Itemized Deductions.      Consequently, those

issues are deemed conceded.    The issue remaining2 for decision is

whether petitioners are liable for the accuracy-related penalty

under section 6662(a).

                              Background

     Some of the facts have been stipulated and are so found.

The stipulation of facts and the exhibits received into evidence

are incorporated herein by reference.      When the petition was

filed, petitioners resided in California.

     During 2005 Mr. Madduri was employed by Gemstone Systems,

Inc. (Gemstone), and Outer Bay.    Mr. Madduri also worked as a

software consultant for CenterBoard, Inc. (CenterBoard).

     For 2005 Mr. Madduri received Forms W-2, Wage and Tax

Statement, from Gemstone and Outer Bay that reported his income

of $106,946 and $88,433.14, respectively, as “Wages, tips, other

comp.”   Those Forms W-2 also show that the employers withheld


     2
      In the stipulation of settled issues the parties also
agreed that: (1) Petitioners received a taxable refund of $644
from the State of California during 2005 that they failed to
report; (2) adjustments to petitioners’ self-employment tax and
their deduction therefor are computational and are to be resolved
consistent with the Court’s decision pursuant to secs. 164(f),
1401, and 1402; and (3) petitioners’ claimed deductions related
to their 2002 Mercedes ML500, which was placed into service
before 2005.
                               - 4 -

Federal income taxes and Social Security and Medicare (FICA)

taxes and that those employers had established section 401(k)

accounts for Mr. Madduri.   Mr. Madduri also received a Form 1099-

MISC, Miscellaneous Income, from CenterBoard that reported Mr.

Madduri’s income of $22,725 as nonemployee compensation.   This

Form 1099-MISC shows that CenterBoard did not withhold Federal

income or FICA taxes and that it did not establish a section

401(k) account for Mr. Madduri.

     Mr. Madduri reported the income he received from Gemstone on

line 7 of petitioners’ 2005 Form 1040, U.S. Individual Income Tax

Return.   Mr. Madduri, however, reported the income he received

from Outer Bay (and CenterBoard) on a Schedule C.   Mr. Madduri

believed that he was an independent contractor rather than an

employee of Outer Bay because he had informed Outer Bay that he

was “going to * * * [Gemstone] as a regular employee” and “[he]

thought it was a short-term contract.”   In short, Mr. Madduri

reported “$117,358[3] [sic] of Form W-2 wages on line 7 of their

2005 Form 1040” and a net profit of $33,7444 on their Schedule C.


     3
      Apparently, the rounded amount consists of: $106,946
(Gemstone “wages”) + $6,034 (Mrs. Madduri’s Macy’s wages) +
$1,935 (sec. 401(k) income excluded from Mr. Madduri’s taxable
wages in excess of the maximum allowable exclusion) + $2,441
(“medical FSA income” income excluded from Mr. Madduri’s taxable
wages in excess of the maximum allowable exclusion) = $117,356.
     4
      The rounded amount consists of: $88,433 (Outer Bay
“wages”) + $22,725 (CenterBoard nonemployee compensation) -
$64,761 (total expenses) - $12,653 (sec. 280A expenses for the
                                                   (continued...)
                                 - 5 -

     Respondent, on the other hand, determined that petitioners

received and failed to report “Taxable Wages Total” of $201,413,

consisting of:     $106,946 (Gemstone “wages”) + $6,034 (Mrs.

Madduri’s Macy’s wages) + $88,433 (Outer Bay “wages”).     In

pertinent part, respondent proposed the following adjustments:

                                                    Reported to
           Item                   Shown on          IRS or as
                                  return            corrected

     Taxable “wages”             $117,358           $201,413
     Taxable income               151,829            240,989
     Tax                           32,244             60,118

     Respondent, however, made no adjustments to the items

reported on petitioners’ Schedule C.

                              Discussion

     Initially, the Commissioner has the burden of production

with respect to any penalty, addition to tax, or additional

amount.   Sec. 7491(c).    The Commissioner satisfies this burden of

production by coming forward with sufficient evidence that

indicates that it is appropriate to impose the penalty.     See

Higbee v. Commissioner, 116 T.C. 438, 446 (2001).     Once the

Commissioner satisfies this burden of production, the taxpayer

must persuade the Court that the Commissioner’s determination is

in error by supplying sufficient evidence of an applicable

exception.   Id.



     4
      (...continued)
business use of their home) = $33,744.
                                   - 6 -

        In pertinent part, section 6662(a) and (b)(1) and (2)

imposes an accuracy-related penalty equal to 20 percent of the

underpayment that is attributable to negligence or disregard of

rules or regulations or a substantial understatement of income

tax.5       A substantial understatement of income tax exists if the

amount of the understatement for the taxable year exceeds the

greater of 10 percent of the tax required to be shown on the

return for the taxable year or $5,000.       Sec. 6662(d)(1)(A).   The

term “understatement” means the excess of the amount of the tax

required to be shown on the return for the taxable year over the

amount of the tax imposed that is shown on the return less any

rebate as defined by section 6211(b)(2).       Sec. 6662(d)(2)(A).

The amount of the understatement is reduced by the portion of the

understatement that is attributable to:       (1) The taxpayer’s tax

treatment of the item if there is or was substantial authority

for the treatment; or (2) any item if the relevant facts

affecting the item’s tax treatment are adequately disclosed in

the return or in a statement attached to the return and there is

a reasonable basis for the taxpayer’s tax treatment of the item.

Sec. 6662(d)(2)(B).




        5
      Because the Court finds that petitioners substantially
understated their income tax, the Court need not discuss whether
they were negligent or disregarded rules or regulations. See
sec. 6662(b); Fields v. Commissioner, T.C. Memo. 2008-207.
                                 - 7 -

      Petitioners have not proven that they satisfy the

substantial authority and adequate disclosure provisions.     See

sec. 6662(d)(2)(B).    Thus, as determined in the notice of

deficiency, the difference between the correct and reported taxes

is $27,874, which exceeds 10 percent of the tax required to be

shown of $60,118.6    See sec. 6662(d)(1)(A).   The Court therefore

finds that petitioners substantially understated their 2005

income tax and that respondent has met his burden of production.

      Section 6664(c)(1), however, provides an exception to the

section 6662(a) penalty:    no penalty is imposed with respect to

any portion of an underpayment if it is shown that there was

reasonable cause therefor and the taxpayer acted in good faith.

Section 1.6664-4(b)(1), Income Tax Regs., incorporates a facts

and circumstances test to determine whether the taxpayer acted

with reasonable cause and in good faith.    The most important

factor is the extent of the taxpayer’s effort to assess his

proper tax liability.    Id.   “Circumstances that may indicate

reasonable cause and good faith include an honest

misunderstanding of fact or law that is reasonable in light of

* * * the experience, knowledge and education of the taxpayer.”

Id.




      6
      The Court notes that these figures will increase to take
into account the parties’ concessions and adjustments for
computational matters. See supra note 2.
                               - 8 -

     Mr. Madduri testified that through an innocent mistake he

reported on Schedule C the income he received as compensation for

services even though Outer Bay reported the income as “Wages,

tips, other comp.” on a Form W-2 that was provided to him.      Mr.

Madduri testified that he believed that he was not an employee of

Outer Bay because he was working as a short-term contractor

performing consulting.   Mr. Madduri testified that when he asked

Outer Bay for a Form 1099, he was told that because there were

only a few months left on the contract, Outer Bay wanted to

continue on a Form W-2 since he was on a Form W-2 in the

preceding year and did not have his own corporation.    According

to Mr. Madduri:   “Turbo-tax [allowed him] to put W-2 into

Schedule C, so then [he] thought it is legal.”

     Mr. Madduri had the responsibility to determine and to

substantiate his status as an independent contractor in order to

report his income on Schedule C.     See sec. 6001; Higbee v.

Commissioner, supra at 440; Rusley v. Commissioner, T.C. Memo.

2003-2; D’Acquisto v. Commissioner, T.C. Memo. 2000-239; see also

secs. 31.3121(d)-1(c)(2), 31.3401(c)-1(a) and (b), Employment Tax

Regs.   Mr. Madduri did not do so.   Mr. Madduri performed no

inquiry whatsoever into his status as an independent contractor

or employee.   Mr. Madduri consciously reported the Outer Bay

income on a Schedule C and relied solely on his mistaken belief

that he was an independent contractor.
                                 - 9 -

     Moreover, in view of the facts and circumstances here, the

Court finds that Mr. Madduri’s mistaken belief was neither

reasonable nor in good faith.    Specifically, Mr. Madduri worked

as a software consultant for CenterBoard and received in 2005 a

Form 1099-MISC, reporting his income as nonemployee compensation,

while Outer Bay and Gemstone provided him with Forms W-2,

reporting his income as “Wages, tips, other comp.”; Outer Bay and

Gemstone funded a section 401(k) account for Mr. Madduri while

CenterBoard did not;7 Outer Bay and Gemstone withheld Federal

income and FICA taxes while CenterBoard did not; his salary, work

hours, and projects at Outer Bay did not significantly change in

2005 despite the purported consulting contract; and he willingly

accepted the Form W-2 from Outer Bay and did not seek corrected

Forms W-2 or 1099-MISC from Outer Bay.      See D’Acquisto v.

Commissioner, supra.   In addition, Mr. Madduri provided no

evidence of the purported consulting contract with Outer Bay and

called no witnesses to corroborate his testimony about the

purported consulting contract.    See id.    Although Mr. Madduri

explained that Outer Bay was acquired by Hewlett-Packard and that

it allegedly said that it could not help him, the Court,

nonetheless, does not accept his self-serving explanation.      See


     7
      The terms “qualified pension, profit-sharing, and stock
bonus plans” include trusts “created or organized in the United
States and forming part of a stock bonus, pension, or profit-
sharing plan of an employer for the exclusive benefit of his
employees or their beneficiaries”. Sec. 401(a) (emphasis added).
                              - 10 -

Urban Redev. Corp. v. Commissioner, 294 F.2d 328, 332 (4th Cir.

1961) (the Court may reject a taxpayer’s uncorroborated

testimony), affg. 34 T.C. 845 (1960).

     In short, petitioners have not established that they acted

with reasonable cause and in good faith.    Respondent’s

determination is sustained.

     To reflect the foregoing,


                                           An appropriate order will

                                   be issued, and decision will

                                   be entered under Rule 155.
