                          T.C. Memo. 2003-10



                        UNITED STATES TAX COURT



          DENNIS J. AND CAROL R. KRAUS, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 2009-01.              Filed January 9, 2003.


     Dennis J. and Carol R. Kraus, pro sese.

     Michael W. Berwind, for respondent.



                MEMORANDUM FINDINGS OF FACT AND OPINION


     GERBER, Judge:     Respondent determined deficiencies in

petitioners’ 1997 and 1998 income tax of $10,069 and $10,337,

respectively.    Respondent also determined penalties under section

6662(a)1 for 1997 and 1998 of $4,027.60 and $4,134.80,


     1
       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, unless otherwise
                                                   (continued...)
                               - 2 -

respectively.2   The issues remaining for our consideration are:

(1) Whether Dennis J. Kraus (petitioner) was entitled to report

income and expenses on a Schedule C, Profit or Loss From

Business; (2) whether petitioner is entitled to use cost of goods

sold in computing his gross income; (3) whether petitioner is

entitled to claim deductions for an office in his home; (4)

whether petitioner is entitled to certain deductions claimed on

Schedules C; (5) whether petitioners are liable for accuracy-

related penalties for negligence under section 6662(b)(1); and

(6) whether the burden of proof is on or shifted to respondent

under section 7491.

                         FINDINGS OF FACT3

     At the time their petition was filed, petitioners were

husband and wife and resided at Huntington Beach, California.

Petitioner was a member of the International Brotherhood of

Teamsters, Bakery Drivers Local Union No. 952 (Local 952).    He

delivered bakery goods provided by the Millbrook Bread division

of Interstate Brands Corp. (IBC).   IBC was in the business of


     1
      (...continued)
indicated.
     2
       Respondent determined that petitioners were liable for
gross valuation misstatement penalties under sec. 6662(h). On
brief, respondent conceded that his determination with respect to
that penalty was erroneous and that petitioners are not liable
for any penalty under sec. 6662(h).
     3
       The parties’ stipulated facts are incorporated by this
reference.
                                 - 3 -

baking and delivering bakery goods to customers.      All

petitioner’s deliveries of bakery goods were subject to the terms

and conditions of a collective bargaining agreement between Local

952 and IBC (union agreement).    Petitioner markets and delivers

the bakery goods to stores, restaurants, and other institutions.

     Petitioner was required to wear a uniform bearing the name

“Millbrook Friday Breads”, and he was referred to as a “route

sales driver” by IBC.    He drove an IBC-owned truck, for which IBC

provided maintenance and gasoline.       Petitioner had no investment

of any consequence in facilities or equipment used in the

business of baking and delivering bakery products.      Normally, he

would “punch a time clock” upon arrival and at the conclusion of

his workday.    After he arrived at IBC, petitioner would load the

truck with IBC bakery products which he delivered to IBC’s

customers in a sales territory that IBC assigned to him.

     Petitioner had no ownership interest in the bakery goods he

delivered, and all invoices to customers were issued in the name

of IBC.    IBC controlled any credit terms offered to customers,

and petitioner earned a commission for bakery goods delivered,

even where the customer failed to pay IBC for the delivered

products.    For the most part, petitioner’s working relationship

with IBC was contained in the union agreement between Local 952

and IBC.    Under that union agreement, petitioner received a base

salary plus commissions that were based on the amount of net
                                - 4 -

sales of goods delivered to IBC customers.    IBC had the right to

discharge petitioner for certain infractions specified in the

union agreement.   IBC provided petitioner with paid holidays,

vacations, and sick and funeral leave.   In addition, IBC provided

petitioner with severance pay benefits and coverage under pension

and health benefit plans.    Normally, petitioner’s sales route was

based on driver seniority.

     Petitioner’s compensation from his activity was reported to

him and the Government by IBC as wages on a Form W-2, Wage and

Tax Statement.   For 1997 and 1998, IBC reported wages of $45,700

and $42,940, respectively, to petitioner.    For 1997 and 1998,

petitioners deducted $7,965 and $6,443, respectively, for home

office expenses.   During the years in issue, one of the bedrooms

in petitioner’s home was converted into an office which he used

for budget tracking and promotional and other work.    IBC did not

require petitioner to maintain an office in his home as a

condition of employment.

     Respondent concedes that if the Court finds that petitioners

are not entitled to home office deductions under section 280A,

then petitioners are entitled to the following additional

deductions on Schedules A, Itemized Deductions, for 1997 and

1998:
                              - 5 -

          Item                               1997     1998

     Home mortgage interest               $7,791     $5,266
     Real property tax                       600        600
     DMV renewal fees                         39         39

     Petitioner, on the 1997 and 1998 Federal income tax returns,

claimed that he was entitled to report income and expenses on a

Schedule C because he was a “statutory employee” in accord with

Rev. Rul. 90-93, 1990-2 C.B. 33.   Petitioner reported gross

receipts of $45,700 for 1997 and $42,940 for 1998 (the amounts

reflected on the Forms W-2) on Schedule C of each return.

Petitioner, for 1997 and 1998, reduced gross receipts by $6,170

and $6,012, respectively, as cost of goods sold.    On each return,

petitioner claimed that the cost of goods sold was an inventory

adjustment for stale and promotional goods.

     On the Schedules C for 1997 and 1998, petitioner claimed the

following deductions from gross income:

      Claimed deduction               1997           1998

     Car and truck expense         $1,890           $2,295
     Legal and professional           800              750
     Insurance                      1,200             -0-
     Interest                       3,615            5,361
     Other                            703            1,788

Respondent disallowed all of petitioner’s claimed Schedule C

deductions for lack of substantiation.
                                 - 6 -

                                OPINION

A.   Section 7491--Burden of Proof

      We first consider the questions raised concerning the burden

of proof under section 7491.4    Petitioners contend that the

burden of proof should be placed on respondent under section

7491.     Section 7491(a) generally provides that the burden of

proof shall be on the Commissioner with respect to any factual

issue relevant to the taxpayer’s liability for tax where the

taxpayer introduces credible evidence with respect to any such

issue.     The burden is not placed on the Commissioner unless a

taxpayer has complied with requirements to substantiate the item

in issue and has maintained required records and cooperated with

reasonable requests by the Commissioner for documents or

information.     Sec. 7491(a)(2)(A) and (B)

      Respondent contends that petitioners have not complied with

the substantiation requirements.     Petitioners contend that their

maintenance of computer or machine sensible records was

sufficient to meet the section 7491 record requirement.

      We find it unnecessary to decide whether the burden of proof

is on respondent because we have decided these issues on a

preponderance of the evidence.



      4
       Sec. 7491 is effective for Court proceedings arising in
connection with examinations commencing after July 22, 1998. See
Internal Revenue Service Restructuring and Reform Act of 1998,
Pub. L. 105-206, sec. 3001(a), 112 Stat. 726.
                                - 7 -

      By determining a penalty under section 6662(a), respondent

had the “burden of production * * * with respect to the liability

of any individual for any penalty”.     Sec. 7491(c).   Because we

have decided that petitioners are not liable for a section 6662

penalty, there is no need to address the question of the burden

on that issue.

B.   Petitioner’s Status as an Employee

      Petitioner’s status as an employee is important in this case

with respect to his ability to claim deductions in arriving at

gross income on a Schedule C.   Petitioner claims that he is not

an employee and relies on sections 3121(d)(3) and 3508(b)(2).        In

effect, petitioner claims to be self-employed and engaged in a

trade or business.    Petitioner’s entitlement to claim that status

depends on whether petitioner is a “statutory” or “common law”

employee.   The use of the term “common law employee” has evolved

from the definition of an “employee” for employment tax purposes

in section 3121(d).   In particular, section 3121(d)(2) defines an

“employee” as “any individual who, under the usual common law

rules applicable in determining the employer-employee

relationship, has the status of an employee”.

      The term “statutory employee” has been commonly used to

refer to employees whose status has been specifically provided

for in paragraphs (1), (3), and (4) of section 3121(d).      Those

paragraphs describe other individuals whose employment status
                               - 8 -

does not generally depend on the common law principles.    One such

category of statutory employee, which is relied on by petitioner,

is described in section 3121(d)(3)(A) as follows:   “an agent-

driver or commission-driver engaged in distributing meat

products, vegetable products, fruit products, bakery products,

beverages (other than milk), or laundry or dry-cleaning services,

for his principal.”   If petitioner can show that he comes within

that definition and that he is not a “common law employee” as set

forth in section 3121(d)(2), he will be entitled to use Schedule

C to report his income and deductions.

     Petitioner also relies on section 3508, which affords

nonemployee status to certain statutorily defined classes of

activities.   In particular, that section applies to real estate

agents and direct sellers.   Petitioner contends that he is a

direct seller.

     Generally, a “direct seller” is defined in section

3508(b)(2)(A) as a person engaged in the trade or business of

either selling consumer products in the home as opposed to a

permanent retail establishment or delivering or distributing

newspapers or shopping news.   Section 3508(b)(2)(B) also requires

that to qualify for direct seller status, petitioner must receive

renumeration related to sales, rather than to the number of hours

worked.   Finally, section 3508(b)(2)(C) requires that petitioner

perform services pursuant to a written contract that provides
                                - 9 -

that he is not treated as an employee with respect to those

services for Federal tax purposes.

     At the outset, petitioner does appear to come within the

rather narrow definition of a “direct seller”.    Petitioner

appears to partially meet the second test in that his

remuneration was based, in part, on sales as opposed to hours

worked.    However, the union contract, which governed petitioner’s

relationship with IBC, did not provide that he was not to be

treated as an employee with respect to those services for Federal

tax purposes.   Accordingly, petitioner is not entitled under

section 3508 to report income and deductions on a

Schedule C.

     With respect to petitioner’s claim that he is not a common

law employee and that he is a statutory employee, we first

consider whether he is a common law employee.    If petitioner

falls within the definition of common law employee, he is

precluded from relying on section 3121(d)(3)(A).    See Ewens &

Miller, Inc. v. Commissioner, 117 T.C. 263, 269 (2001).     The

question of whether an individual is a common law employee is one

of fact.    Profl. & Executive Leasing, Inc. v. Commissioner, 89

T.C. 225, 232 (1987), affd. 862 F.2d 751 (9th Cir. 1988).

     As a guide to deciding common law employee status, courts

have used seven factors.   In Weber v. Commissioner, 103 T.C. 378,
                             - 10 -

387 (1999), affd. 60 F.3d 1104 (4th Cir. 1995), relevant factors

and governing legal principles were described as follows:

     (1) The degree of control exercised by the principal
     over the details of the work; (2) which party invests
     in the facilities used in the work; (3) the opportunity
     of the individual for profit or loss; (4) whether or
     not the principal has the right to discharge the
     individual; (5) whether the work is part of the
     principal's regular business; (6) the permanency of the
     relationship; and (7) the relationship the parties
     believe they are creating. Professional & Executive
     Leasing, Inc. v. Commissioner, supra at 232; Simpson v.
     Commissioner, supra at 984-985. No one factor dictates
     the outcome. Rather, we must look at all the facts and
     circumstances of each case. Azad v. United States, 388
     F.2d 74, 76 (8th Cir. 1968); Professional & Executive
     Leasing, Inc. v. Commissioner, supra at 232; Simpson v.
     Commissioner, supra at 985; Gamal-Eldin v.
     Commissioner, T.C. Memo. 1988-150, affd. without
     published opinion 876 F.2d 896 (9th Cir. 1989).
          The "right-to-control" test is the crucial test to
     determine the nature of a working relationship.
     Matthews v. Commissioner, 92 T.C. 351, 361 (1989),
     affd. 907 F.2d 1173 (D.C. Cir. 1990). The degree of
     control is one of great importance, though not
     exclusive. Atlantic Coast Life Ins. Co. v. United
     States, 76 F. Supp. 627, 630 (E.D.S.C. 1948).
     Accordingly, we must examine not only the control
     exercised by an alleged employer, but also the degree
     to which the alleged employer may intervene to impose
     control. Radio City Music Hall Corp. v. United States,
     135 F.2d 715, 717 (2d Cir. 1943); DeTorres v.
     Commissioner, T.C. Memo. 1993-161. In order for an
     employer to retain the requisite control over the
     details of an employee's work, the employer need not
     stand over the employee and direct every move made by
     that employee. Professional & Executive Leasing, Inc.
     v. Commissioner, supra at 234; Simpson v. Commissioner,
     supra at 985; Gierek v. Commissioner, T.C. Memo. 1993-
     642; Atlantic Coast Life Ins. Co. v. United States,
     supra at 630. Also, the degree of control necessary to
     find employee status varies according to the nature of
     the services provided. Reece v. Commissioner, T.C.
     Memo. 1992-335; Pulver v. Commissioner, T.C. Memo.
     1982-437.
                               - 11 -

     With that guidance, we consider whether petitioner is a

common law employee.   Generally, petitioner was engaged in

driving IBC’s truck and representing IBC in the sale and delivery

of its products to customers in a specific geographical area.

Petitioner was responsible for the relationship with the

customer.    Petitioner characterizes that relationship as “city

salesman, working from a truck” and not mere “deliveryman”.

     We first consider the degree of IBC’s control over

petitioner (right to control).    That factor is an important one

in discerning petitioner’s relationship to IBC.    See Weber v.

Commissioner, supra at 387.    The degree of control necessary to

find employee status varies with the nature of the services

provided by the worker.    Id. at 388.   “To retain the requisite

control over the details of an individual’s work, the principal

need not stand over the individual; it is sufficient if he has

the right to do so. * * * see sec. 31.3401(c)-1(b), Employment

Tax Regs.”    Ewens & Miller, Inc. v. Commissioner, supra at 270.

     Respondent contends that under the terms of the union

agreement between IBC and Local 952, IBC controls petitioner, by

controlling his sales territory, hours of work, credit terms that

he can extend to customers, and general course of conduct.     In

addition, respondent points out that IBC requires petitioner to

wear an IBC uniform and provides him with a delivery truck in

good working order, gasoline, and maintenance.    In addition, IBC
                              - 12 -

provides petitioner with pension and health benefits, paid sick

leave, paid funeral leave, paid holidays and vacations, and

severance pay benefits.   Finally, respondent points out that IBC

provides petitioner with a Form W-2 (as opposed to a Form 1099-

NEC) and that IBC pays petitioner’s Social Security and

unemployment taxes.

     Petitioner counters that he is an agent, as opposed to an

employee, because he must work as many hours as it takes to

finish the job.   He also points out that he is paid a base salary

and commissions on sales, as opposed to an hourly rate.    Finally,

he argues that IBC’s issuance of a Form W-2 is not dispositive of

the characterization of his relationship with IBC.

     On the basis of the terms of the union agreement between IBC

and Local 952 and the other aspects of petitioner’s relationship

with IBC, the control factor indicates an employer-employee

relationship.

     Next we consider respondent’s contention that IBC had the

right to discharge petitioner for certain specified infractions.

We do not find this aspect to be significant because IBC and/or

petitioner would each have the option to terminate their

relationship irrespective of whether it was one of employment or

agency.   Under the union agreement, petitioner could be

discharged by IBC if:   (1) He worked on his route after his daily

checkout, on holidays or Sundays, or on his day off; (2) he split
                              - 13 -

a commission; (3) he illegally possessed a controlled substance

or was drunk, dishonest, or guilty of gross misconduct or

insubordination; (4) he “puts private label products on the bread

table”; or (5) his performance is deemed unsatisfactory.

However, IBC was required to meet with the union regarding the

conduct and to notify the union if petitioner were suspended or

discharged.

     Although the first, second, and fourth of the above-listed

reasons for discharge appear to be unique to the type of work and

union agreement, the third and fifth are broad categories of

reasons for which IBC could have discharged petitioner.    Those

categories are of the type that may be associated with an

employer-employee relationship.   Even though the union contract

provided the union’s right to be involved in the discharge

process, that aspect does not diminish the fact that IBC could

discharge petitioner for poor performance.

     Lastly, the record reflects that petitioner had little or no

investment in facilities or equipment.

     The relationship between petitioner and IBC is, in

substantial part, governed by the union agreement between

petitioner’s union and IBC.   The terms of the agreement provide

for a relationship that is more akin to that of an employer-

employee (common law) than that of a self-employed individual or

an agent, as contended by petitioner.    We therefore hold that
                              - 14 -

petitioner is a common law employee of IBC.   As a common law

employee, petitioner is not entitled to be classified as a

statutory employee as that term is described in section

3121(d)(3)(A).

C.   Whether Petitioner Is Entitled to a Deduction in Arriving at
     Gross Income for Returned Merchandise

      In arriving at gross receipts on his Schedule C, petitioner

reduced gross receipts by $6,170 and $6,012, for 1997 and 1998,

respectively, as “cost of goods sold”.   Petitioner relies on

section 458 and the case of Hachette USA, Inc. v. Commissioner,

105 T.C. 234 (1995), as support for his claimed reductions to

gross receipts.

      Section 458 is an elective provision that permits the

exclusion from gross income of amounts refunded by the taxpayer

upon the return of specified merchandise, i.e., a magazine,

paperback, or record, if the taxpayer is on the accrual basis of

accounting and in the business of selling such goods.   Respondent

contends that petitioner is not entitled to use section 458

because petitioner:   (1) Was not in the business of distributing

or selling magazines, paperbacks, or records, (2) was not on the

accrual method of accounting, (3) did not own the products

delivered, and (4) did not maintain inventories.

      We agree with respondent and hold that petitioner is not

entitled to any cost of goods sold adjustment for 1997 or 1998.

The union agreement expressly provides that petitioner had no
                              - 15 -

responsibility for stale or unsold goods and that he would

receive a full credit (be entitled to retain commissions) for

such merchandise.

      At trial, petitioner explained that the cost of goods sold

adjustment was based on commissions that could have been earned

on products that were not sold because they were returned to IBC.

We are at a loss to understand how petitioner could have been

out-of-pocket for the cost of such items under these

circumstances, especially where IBC provided petitioner with a

credit for returned merchandise and IBC was required to pay

commissions to petitioner even if the customer returned the

merchandise.

D.   Petitioner’s Entitlement to Home Office Expenses

      On the 1997 and 1998 income tax returns, petitioner claimed

$7,965 and $6,443, respectively, as home office expenses.

Section 280A generally prohibits the deduction of the costs of a

taxpayer’s residence.   Section 280A(c)(1), however, permits a

deduction for the allocable portion of a residence that is

regularly and exclusively used as a taxpayer’s principal place of

business or as a place of business which is used by customers in

the normal course of the taxpayer’s trade or business.

      An employee is entitled to a home office deduction only if

such an office is required for the employer’s convenience.

Frankel v. Commissioner, 82 T.C. 318, 325-326 (1984).    In that
                                - 16 -

regard, petitioner admitted at trial that his employer did not

require him to maintain an office in petitioner’s home.

      Accordingly, petitioner would be entitled to a home office

deduction only if he were found to have a trade or business;

i.e., were an independent contractor or self-employed.    Because

we have already found that petitioner is an employee of IBC, he

is not entitled to claim a deduction for home office expenses.

E.   Petitioner’s Entitlement to Certain Schedule C Deductions

      On the Schedules C of their 1997 and 1998 income tax

returns, petitioners claimed various deductions.    As decided

earlier in this opinion, petitioner is not self-employed and thus

is not entitled to claim deductions on a Schedule C.    Respondent

also contends that petitioners are not entitled to the home

office or Schedule C deductions because of their failure to

substantiate them.5

      Petitioner maintained computer records on Quicken which were

not accepted by respondent as sufficient to establish the

expenses claimed.     In that regard, petitioner apparently did not



      5
       Because of respondent’s concession and because petitioners
were found not to be entitled to home office or Schedule C
deductions, petitioners are entitled to the following Schedule A
deductions:

            Category             1997      1998     Schedule A

      Home mortgage interest   $7,791    $5,266      Line 10
      Real property taxes         600       600      Line 6
      DMV renewal fees             39        39      Line 8
                              - 17 -

maintain documents showing that the claimed expenses were

incurred or paid.

      Petitioners rely on Rev. Proc. 98-25, 1998-1 C.B. 689, which

provides for the use of “machine sensible records” like Quicken

to satisfy their record keeping requirements.    Petitioners’

understanding was that the revenue procedure permitted computer

records in lieu of other records that are required to be

maintained under section 6001.   Under Rev. Proc. 98-25, section

11, 1998-1 C.B. at 693, however, taxpayers are not relieved from

the responsibility of retaining the hardcopy records from which

the computer records were derived; i.e., bills, invoices, etc.

received in the ordinary course of business.    In that regard,

petitioners professed to have only the Quicken printouts.

Accordingly, petitioners have failed to show that they are

entitled to home office deductions claimed on their Schedule C

for 1997 or 1998 in excess of the amounts that respondent has

conceded they would be entitled to as Schedule A deductions.

F.   Petitioners’ Liability for Section 6662 Penalties

      Respondent determined that petitioners were liable for

penalties under section 6662(a) and (h).   Respondent has conceded

that petitioners are not liable for a penalty under section

6662(h) but continues to maintain that petitioners are liable for

a penalty under section 6662(a) for negligence because they

failed to maintain adequate records.
                               - 18 -

     Section 6662 provides for an accuracy-related penalty equal

to 20 percent of the underpayment if the underpayment was due to

a taxpayer’s negligence.    See sec. 6662(a) and (b)(1).    A

taxpayer is negligent when he or she fails “‘to do what a

reasonable and ordinarily prudent person would do under the

circumstances.’”   Korshin v. Commissioner, 91 F.3d 670, 672 (4th

Cir. 1996) (quoting Schrum v. Commissioner, 33 F.3d 426, 437 (4th

Cir. 1994), affg. in part, vacating and remanding in part T.C.

Memo. 1993-124), affg. T.C. Memo. 1995-46.

     As pertinent here, “negligence” includes the failure to make

a reasonable attempt to comply with the provisions of the

Internal Revenue Code and also includes any failure to keep

adequate books and records or to substantiate items properly.

See sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.

     However, a taxpayer may avoid the application of the

accuracy-related penalty by proving that he or she acted with

reasonable cause and in good faith.     See sec. 6664(c).   Whether a

taxpayer acted with reasonable cause and good faith is measured

by examining the relevant facts and circumstances, and most

importantly, the extent to which he or she attempted to assess

the proper tax liability.    See Neely v. Commissioner, 85 T.C. 934

(1985); Stubblefield v. Commissioner, T.C. Memo. 1996-537; sec.

1.6664-4(b)(1), Income Tax Regs.
                              - 19 -

     Petitioners maintained computer records for the disputed

deduction items.   Those items included deductions claimed on

Schedules C and separate home office expenses.     We decided that

petitioners were not entitled to home office deductions.     We also

decided that petitioners were not entitled to itemized deductions

in excess of those respondent conceded.    We note that the amount

of itemized deductions respondent conceded represented

substantially all of the home office deductions petitioners

claimed.   With respect to petitioners’ claimed Schedule C

deductions, we found that petitioners were not entitled to them

because of the characterization of petitioner’s relationship with

IBC as an employee, rather than as an agent or self-employed

individual.6   That characterization is based on complex concepts.

Under the circumstances, we hold that petitioners acted with

reasonable cause and in good faith.    Accordingly, petitioners are

not liable for a section 6662(a) penalty for 1997 or 1998.

     To reflect the foregoing,


                                      Decision will be entered

                                 under Rule 155.




     6
       It also appears that a small portion of the deductions
petitioners claimed on their Schedules C was conceded by
respondent.
