                           T.C. Memo. 1996-459



                      UNITED STATES TAX COURT



            JUNG K. YOON AND HEE S. YOON, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 9034-94.                       Filed October 10, 1996.



     John E. Leeper and Towner S. Leeper, for petitioners.

     Frank R. Hise and Gerald L. Brantley, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION

     COHEN, Chief Judge:      Respondent determined deficiencies, an

addition to tax, and penalties in petitioners' Federal income

taxes as follows:

                                    Addition to Tax and Penalty
     Year       Deficiency        Sec. 6651(a)(1)     Sec. 6663(a)

     1989        $47,002                --               $35,251.50
     1990         76,128                --                56,528.00
     1991         83,068              $9,071              61,157.00
                               - 2 -

Respondent's answer asserted the section 6662(a) accuracy-related

penalty in the alternative to the section 6663(a) fraud penalty.

     Unless otherwise indicated, all section references are to

the Internal Revenue Code in effect for the years in issue, and

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

Procedure.

     After concessions by respondent, the issues remaining for

decision are:   (1) Whether petitioners received unreported income

during the years in issue, including income from their wholly

owned S corporation during 1991; (2) whether petitioners are

liable for the section 6651(a)(1) addition to tax for 1991; and

(3) whether petitioners are liable for the section 6662(a)

accuracy-related penalty for the years in issue.

Preliminary Matter

     Due to petitioners' failure to comply with this Court's

standing pretrial order and hearsay objections by the parties set

forth in the stipulations, many of the exhibits offered into

evidence were not received at the trial of this case.   During the

trial, petitioners' counsel offered to withdraw all objections to

respondent's exhibits if respondent would in turn withdraw all

objections to petitioners' exhibits.   Thereafter, the Court

received a document from respondent in which respondent's

objections were withdrawn.   We have therefore proceeded with the

disposition of this case considering all of the exhibits attached
                                 - 3 -

to the stipulation of facts and supplemental stipulation of facts

and an additional exhibit produced at trial.

                         FINDINGS OF FACT

     Some of the facts have been stipulated, and the stipulated

facts are incorporated in our findings by this reference.    At the

time the petition was filed, Jung K. Yoon and Hee S. Yoon

(petitioners) resided in El Paso, Texas.

     Jung K. Yoon (Yoon) was born in Seoul, Korea.   Yoon

immigrated to the United States in 1975.

     During 1989, 1990, and 1991, petitioners owned and operated

a general merchandise store specializing in low-cost items in

South El Paso under the name L.A. Trading.   Most of petitioners'

customers came into the United States from Juarez, Mexico.

During the years in issue, Yoon worked 14 hours a day, 7 days a

week, and he never took a vacation.

     In 1989, L.A. Trading was operated as a sole proprietorship.

On January 31, 1990, petitioners incorporated Jung K. Yoon, Inc.

(JKY), electing treatment as an S corporation.   JKY operated the

merchandise business that was previously operated as a sole

proprietorship.   During 1990 and 1991, petitioners owned

100 percent of the stock of JKY.    By the end of 1995, petitioners

closed the store as a result of the downturn in the Mexican

economy and the devalued peso.

     JKY's suppliers, mainly Korean-owned businesses, were

primarily located in Los Angeles, California.    Yoon entertained
                                      - 4 -

JKY's suppliers on occasion in hopes of getting better prices and

better payment plans.       JKY purchased over $1 million in inventory

in each of the years in issue.           Yoon frequently traveled to Los

Angeles to purchase merchandise.          Yoon also traveled to Las

Vegas, Nevada, two or three times each year to attend trade shows

and to purchase merchandise.         Yoon has no relatives in Los

Angeles or Las Vegas.

     Petitioners maintained several personal and business

accounts in at least two banks during the years in issue.

Petitioners' children also maintained bank accounts during the

years in issue.

     During the years in issue, petitioners acquired the

following properties:

                                                            Purchase
              Date                  Address                  Price

            03/16/89          515   South Stanton           $447,000
            04/18/89          519   South Stanton           $450,000
            05/02/89          413   8th Street              $300,000
            04/30/91          932   Cherry Hill             $320,000

     Petitioners incurred the following indebtedness for the

purchase of real property during the years in issue:

     Date          Amount       Lender                  Reason

     1989          $ 80,000    Jae Gilpin        Purchase of 519 South Stanton
     1989          $350,000    Teresa Baca       Purchase of 515 South Stanton
     1989          $300,000    Julia Samaniego   Purchase of 519 South Stanton
     1989          $270,000    Roberto Okubo     Purchase of 413 E. 8th
                                                 1
     1989          $ 60,000    Su Chon Han
     1990          $ 30,000    Doo Sung          Purchase of 932 Cherry Hill
     1991          $ 3,000     Doo Sung          Purchase of 932 Cherry Hill
            1
              The record is not clear as to the purpose of this loan.
                                - 5 -

Petitioners paid interest on the loan from Jae Gilpin (Gilpin).

Petitioners were required to pay interest on at least a portion

of the loan from Su Chon Han.

     Petitioners also incurred debt related to their purchase of

several automobiles during the years in issue.

     Petitioners had the following personal credit card account

balances:

                Date                    Credit Card Balance

            Dec. 31, 1989                   $20,521.99
            Dec. 31, 1990                    16,413.37
            Dec. 31, 1991                    26,075.24

     JKY had the following nontaxable receipts during 1991:

     Description                             Amount
                                             1
     Loan from Sunwest                        $40,000
                                              1
     Loan from shareholder                      89,530
     Loans from suppliers:
           Price Mart                          5,000
           Almar Sales                        14,000
           La Coqurto                          3,000
     Total                                  $151,530
            1
           Respondent allowed these amounts in the notice of
     deficiency.

JKY had $140,614.37 of sales returns/chargebacks during 1991.

Income Tax Returns

     Patrick Caufield (Caufield) prepared petitioners' 1989

Form 1040, U.S. Individual Income Tax Return, and JKY's 1990

Form 1120S, U.S. Income Tax Return for an S Corporation. Caufield

did not review the tax returns with Yoon because of the

difficulty in communicating with him.      Thomas Hwang prepared

petitioners' 1990 and 1991 Forms 1040 and JKY's 1991 Form 1120S.
                               - 6 -

     The return preparers did not use the cash register tapes

from the business when calculating the amount of gross receipts

to be reported on petitioners' or JKY's Federal income tax

returns.   Petitioners prepared monthly written statements of how

much gross receipts were received by the business.   These

statements, along with other information supplied by petitioners,

were used in the preparation of petitioners' and JKY's returns.

     Petitioners filed joint Federal income tax returns on a cash

basis for each of the years in issue.    Petitioners' 1991 return

was filed on February 22, 1993.

     JKY filed Forms 1120S for its taxable years ended

December 31, 1990, and December 31, 1991, respectively.

Respondent's Examination and Determination

     During an examination of petitioners' returns, the examining

revenue agent requested that petitioners produce bank records and

various other documents.   Petitioners did not produce check

registers or all of the bank statements and canceled checks from

petitioners' various accounts or other records adequate to

determine petitioners' taxable income.   The agent therefore

reconstructed petitioners' income as described below.

     Respondent's Net Worth Calculations

     Respondent computed petitioners' beginning net worth by

calculating bank balances, inventory, personal property, real

property, and other assets owned at the end of 1988 and reducing

this amount by loans and accumulated depreciation.   Any apparent
                               - 7 -

mathematical errors are the result of respondent's rounding off

various amounts.

     The following is respondent's computation of petitioners'

increase in net worth plus personal living expenses for 1989:

                                           12/31/88        12/31/89
     Assets

     Bank account balances

          Cash on hand              $      0.00        $        0.00
          Sunwest - 180-0090126            0.00            15,506.99
          Sun World - 27-02180             0.00             8,226.29
          Surety Savings - 55-46374 15,619.47                   0.00
          Surety Savings - 59-40245    1,648.17                 0.00
          Sun World - 27-02236             0.00             1,754.74
          Sun World - 62-00931             0.00             1,717.29
                                    $ 17,267.64        $   27,205.31

     Inventory                         $270,000.00     $   272,797.00

     Personal property

          Store equipment              $    378.00     $      378.00
          Steel gate                        140.00            140.00
          Improvements                      888.00            888.00
          1982 Chevrolet van             11,629.00         11,629.00
          Display case                      600.00            600.00
          Fixtures                        5,406.00          5,406.00
          Cash register                       0.00          1,188.00
          1989 Isuzu                          0.00         13,317.00
          1988 Cadillac                       0.00         19,973.80
                                       $ 19,041.00     $   53,519.80

     Real property

          515 S. Stanton               $        0.00   $  447,000.00
          519 S. Stanton                        0.00      450,000.00
          413 E. 8th Street                     0.00      300,000.00
                                       $        0.00   $1,197,000.00

     Other assets
          Deposits                     $      530.00          530.00
          Passive loss carryover                0.00       63,413.00
                                       $      530.00   $   63,943.00

     Total assets                      $306,838.64     $1,614,465.11
                              - 8 -

Liabilities

Loans and mortgages

      515 S. Stanton - Baca      $            0.00     $  346,685.42
      519 S. Stanton - Samaniego              0.00        194,072.70
      413 E. 8th - Okubo                      0.00        261,723.45
      Note payable - Sunwest                  0.00        100,000.00
      Note payable - Autos                    0.00         10,012.62
      Mortgage payable - Gilpin               0.00         80,000.00
      Note payable - Cadillac                 0.00         16,676.89
      Note payable - Han                      0.00         60,000.00
                                 $            0.00     $1,069,171.08

Accumulated depreciation

      515 S. Stanton                  $       0.00     $      9,978.00
      519 S. Stanton                          0.00            7,937.00
      413 E. 8th                              0.00            5,159.00
      Store equipment                       190.00              266.00
      Steel gate                             70.00               99.00
      Improvements                          445.00              631.00
      1982 Chevrolet van                  3,815.00            8,615.00
      Display case                          300.00              420.00
      Fixtures                            2,366.00            3,235.00
      Cash register                           0.00            1,188.00
      1989 Isuzu                              0.00            2,660.00
                                      $   7,186.00     $     40,188.00

Total liabilities                     $   7,186.00     $1,109,359.00
                                                       1
Net worth                             $299,653.00       $    505,106.00

Beginning net worth                                         (299,653.00)
Change in net worth                                    $     205,453.00

Personal living expenses                                    124,929.00

Adjusted gross income as corrected                     $    330,382.00

Adjusted gross income per return                            (172,216.00)

Unidentified Income                                    $    158,166.00
      1
        Respondent has conceded that this amount should be reduced
by $800, the trade-in value of a 1980 Buick traded in on the
purchase of the 1989 Isuzu.
                               - 9 -

     The following is respondent's computation of petitioners'

increase in net worth plus personal living expenses for 1990:

                                         12/31/89          12/31/90
     Assets

     Bank account balances

          Cash on hand              $         0.00   $        0.00
          Sunwest - 180-009126           15,506.99        4,432.00
          Sun World - 27-02180            8,226.29       11,922.00
          Sunwest Bank - 1800048108           0.00        5,930.00
          Sunwest Bank - 1850002567           0.00        1,028.00
          Sun World - 27-02236            1,754.74            0.00
          Sun World - 62-00931            1,717.29        3,674.00
          Sunwest Bank - 1800095316           0.00       14,177.00
          Sunwest Bank - 1800096908           0.00        1,355.00
          Cash transferred to JKY             0.00       (8,106.00)
                                    $    27,205.31   $   34,412.00

     Inventory                     $    272,797.00   $        0.00

     Personal property

          Store equipment          $        378.00   $        0.00
          Steel gate                        140.00            0.00
          Improvements                      888.00            0.00
          1982 Chevrolet van             11,629.00            0.00
          Display case                      600.00            0.00
          Fixtures                        5,406.00            0.00
          Cash register                   1,188.00            0.00
          1989 Isuzu                     13,317.00            0.00
          1988 Cadillac                  19,973.80       19,973.80
                                   $     53,519.80   $   19,973.80

     Real property

          515 S. Stanton           $  447,000.00     $  447,000.00
          519 S. Stanton              450,000.00        450,000.00
          413 E. 8th Street           300,000.00        300,000.00
                                   $1,197,000.00     $1,197,000.00

     Capital account - JKY         $          0.00   $   283,043.00

     Unused passive losses         $     63,943.00   $   38,413.00

     Total assets                  $1,614,465.00     $1,572,842.00
                                - 10 -

     Liabilities

     Loans and mortgages

          515 S. Stanton - Baca     $ 346,685.42      $   342,209.68
          519 S. Stanton - Samaniego 194,072.70           182,811.21
          413 E. 8th - Okubo           261,723.45         219,407.65
          Note payable - Sunwest       100,000.00               0.00
          Note payable - Ford Motor     10,012.61               0.00
          Note payable - Cadillac       16,676.89          10,840.33
          Note payable - Han            60,000.00          60,000.00
          Note payable - Gilpin          80,000.00         71,100.00
                                    $1,069,171.07     $   886,368.87

     Accumulated depreciation

          515 S. Stanton           $       9,978.00   $    22,581.00
          519 S. Stanton                   7,937.00        20,635.00
          413 E. 8th                       5,159.00        13,413.00
          Store equipment                    266.00             0.00
          Steel gate                          99.00             0.00
          Improvements                       631.00             0.00
          1982 Chevrolet van               8,615.00             0.00
          Display case                       420.00             0.00
          Fixtures                         3,235.00             0.00
          Cash register                    1,188.00             0.00
          1989 Isuzu                       2,660.00             0.00
                                   $      40,188.00   $    56,629.00

     Total liabilities             $1,109,359.00      $   942,998.00

     Net worth                     $     505,106.00   $   629,844.00

     Beginning net worth                                  (505,106.00)
     Change in net worth                              $    124,738.00

     Personal living expenses                             138,810.00

     Cash withdrawal from JKY capital account             (18,000.00)

     Adjusted gross income as corrected               $   245,548.00

     Adjusted gross income per return                     (37,287.00)

     Unidentified income                              $   208,261.00

     The following is respondent's computation of petitioners'

increase in net worth plus personal living expenses for 1991:
                           - 11 -

                                        12/31/90         12/31/91
Assets

Bank account balances

     Cash on hand              $         0.00      $        0.00
     Sun World - 27-02180            11,922.00            348.00
     Sunwest Bank - 1800048108        5,930.00          5,300.00
     Sunwest Bank - 1850002567        1,028.00            455.00
     Sunwest Bank - 1800095316       14,177.00          4,671.00
     Sunwest Bank - 1800096908        1,355.00          1,466.00

                              $      34,412.00     $   12,240.00

Personal property

     1988 Cadillac            $      19,973.80         19,973.80

Real property

     932   Cherry Hill        $        0.00        $  320,000.00
     515   S. Stanton            447,000.00           447,000.00
     519   S. Stanton            450,000.00           450,000.00
     413   E. 8th Street         300,000.00           300,000.00
                              $1,197,000.00        $1,517,000.00

Capital account - JKY         $     265,043.00     $   519,576.00

Unused passive losses         $      38,413.00     $   12,624.00

Total assets                  $1,554,842.00        $2,081,414.00
                                - 12 -

     Liabilities

     Loans and mortgages

          515 S. Stanton - Baca     $    342,209.68   $   336,734.60
          519 S. Stanton - Samaniego     182,811.21       169,995.27
          413 E. 8th - Okubo             219,407.65             0.00
          Note payable - Sunwest               0.00       172,583.37
          Note payable - Chase            10,840.33         4,270.06
          Note payable - Han              60,000.00        60,000.00
          Note payable - Prudential            0.00       254,378.24
          Note payable - Yi                    0.00       (15,000.00)
          Note payable - Gilpin           71,100.00             0.00
                                    $    886,368.87   $   982,961.54

     Accumulated depreciation

          515 S. Stanton           $      22,581.00   $    35,184.00
          519 S. Stanton                  20,635.00        33,333.00
          413 E. 8th                      13,413.00        21,667.00
                                   $      56,629.00   $    90,184.00

     Total liabilities             $     942,998.00   $1,073,146.00

     Net worth                     $     611,844.00   $1,008,268.00

     Beginning net worth                                  (611,844.00)
     Change in net worth                              $    396,424.00

     Personal living expenses                             186,248.00

     Cash withdrawal from JKY capital account             (133,100.00)

     Adjusted gross income as corrected               $   449,572.00

     Adjusted gross income per return                     (244,010.00)

     Unidentified income                                  $205,562.00

     Respondent prepared the computations of beginning and ending

bank account balances from monthly bank statements and deposit

slips.

     Respondent computed petitioners' increase in ownership of

personal property by calculating the personal property owned at

the end of the year less personal property owned at the beginning
                                - 13 -

of the year.   Third-party records, petitioners' depreciation

schedules, and Department of Motor Vehicles' records were used to

calculate petitioners' ownership of personal property.

     Respondent computed petitioners' increase in the ownership

of real property by determining the real property owned at the

end of the year less what was owned at the beginning of the year.

Respondent obtained the records relating to petitioners'

acquisition of real property from third-party sources.

Respondent used amortization tables to calculate loan balances at

the end of each taxable year.

     All payments from petitioners' personal bank accounts on

credit card account balances were treated as personal living

expenses in respondent's computation of petitioners' net worth.

     Respondent determined petitioners' February 1, 1990,

investment in JKY by netting assets and liabilities transferred

to JKY as follows:
                               - 14 -

     Assets

     Cash-Sunwest                  $ 4,432.00
     Cash-Sun World                   3,674.00
     Deposits                           530.00
     Depreciable assets (business)
          Store equipment               378.00
          Steel gate                    140.00
          Improvements                  888.00
          Chevrolet van              11,629.00
          Display cases                 600.00
          Fixtures                    5,406.00
          Cash register               1,188.00
          1989 Isuzu                 13,317.00
     Inventory                      267,077.55
                                   $309,259.55

     Liabilities

     Note payable-Chevrolet van     $ 10,012.61
     Note payable-Sunwest Bank        91,666.67
     Accumulated depreciation         17,114.00
                                     118,793.28

     Investment in JKY              $190,466.27

     Respondent computed petitioners' December 31, 1990,

investment in JKY by adding the February 1, 1990, investment to

shareholder loans made during the year and income reported by

JKY, less distributions made during the year.

     Investment as of 2/1/90        $190,466.27

     Increased by:
          1990 Income                    47,577.00
          Loans to JKY                   45,000.00

     Decreased by:
          1990 Distributions            (18,000.00)

     Investment as of 12/31/90      $265,043.27

     Respondent computed petitioners' December 31, 1991,

investment in JKY by adding the December 31, 1990, investment to
                               - 15 -

shareholder loans made during the year and income reported by

JKY, less distributions made during the year.

     Investment as of 12/31/90        $265,043.27

     Increased by:
          1991 Income                    165,003.00
          Loans to JKY                    89,530.00

     Decreased by:
          1991 Distributions          (134,105.00)

     Investment as of 12/31/91        $385,471.27

Income Pass-Through--Form 1120S Adjustment

     Respondent based the proposed adjustments to JKY's 1990 and

1991 income on the bank deposit method.      Respondent conceded the

Form 1120S adjustment for taxable year 1990 in the amount of

$38,321 based upon information supplied by petitioners during the

preparation of this case for trial.

                               OPINION

Unreported Income

     The first issue for resolution is whether petitioners

underreported their taxable income for each of the years in

issue.    In this case, the evidence of unreported income consists

of respondent's net worth and bank deposit analyses.     The

validity of those analyses must be examined by applying the

standards set forth in Holland v. United States, 348 U.S. 121

(1954).   Under those standards, respondent must establish, with

reasonable certainty, an opening net worth; and she must

establish that either a likely source of unreported income
                               - 16 -

existed or that she conducted a reasonable investigation of leads

to negate the existence of nontaxable sources of income.      Id. at

132.

       Under the net worth method, income is computed by

determining a taxpayer's net worth at the beginning and end of a

period.    The difference between the amounts is the increase in

net worth.    An increase in a taxpayer's net worth, plus his

nondeductible expenditures, less nontaxable receipts, may be

considered taxable income.    Id. at 125.

       Where the Commissioner has determined a deficiency by using

the net worth method, we may adjust a determination of opening

net worth shown by the trial record to be unrealistic.      Hoffman

v. Commissioner, 298 F.2d 784, 786 (3d Cir. 1962), affg. in part

T.C. Memo. 1960-160; Baumgardner v. Commissioner, 251 F.2d 311,

318 (9th Cir. 1957), affg. T.C. Memo. 1956-112; Potson v.

Commissioner, 22 T.C. 912, 928-929 (1954), affd. sub nom.

Bodoglau v. Commissioner, 230 F.2d 336 (7th Cir. 1956).      Any such

adjustments do not invalidate the presumption of correctness

attaching to other aspects of the Commissioner's deficiency

determination if the determination was not arbitrary.       Hoffman v.

Commissioner, supra at 788.

       Petitioners have raised four areas of dispute with

respondent's calculations, and we address each of these areas

below.
                                - 17 -

     1.   Outstanding Liabilities

     Petitioners contend that respondent failed to reduce

petitioners' net worth by outstanding liabilities, mainly credit

card debts and debts to friends and relatives.

     a.   Credit cards.   Respondent did not include in her net

worth determination petitioners' personal credit card

liabilities.

     Petitioners failed to provide any reliable evidence from

which we can establish or even estimate their credit card

liabilities as of December 31, 1988, or January 1, 1989.    At

trial, petitioners presented, as part of their personal living

expense calculations, schedules prepared by Caufield that state

alleged opening dates of certain credit card accounts.    No

supporting documents were attached to these schedules, and Yoon

did not testify regarding the establishment of any of the credit

card accounts.   Without a reliable opening balance as of

January 1, 1989, we cannot determine whether this debt increased

or decreased during the year.    Thus, we cannot adjust

respondent's net worth determination for 1989 by any credit card

liabilities.

     At trial, petitioners produced a schedule of credit card

balances at the end of 1989, 1990, and 1991 with copies of

certain monthly credit card statements attached.    These schedules

and copies of statements are reliable evidence of petitioners'
                                - 18 -

credit card liabilities.    However, the total reflected on

petitioners' 1990 schedule should be reduced by the balance of a

corporate credit card and by a balance for which there is no

supporting monthly statement.    The total reflected on

petitioners' 1991 schedule should be reduced by the balances of

two corporate credit cards and increased by $100 to correct an

apparent mathematical error.    Because, during 1989, petitioners

operated L.A. Trading as a sole proprietorship, we need not

reduce the total reflected on petitioners' 1989 schedule by the

business (corporate) credit card.    We have determined from the

evidence that petitioners had the personal credit card balances

set forth in our Findings of Fact.       Respondent's calculations of

petitioners' net worth for 1990 and 1991 must be adjusted to

reflect the credit card balances as liabilities.

     b.   Debts to friends and relatives.      Petitioners contend

that respondent failed to take into account several liabilities

that petitioners incurred to various friends and relatives.

     Yoon testified at trial that he borrowed $30,000 in 1990 and

$3,000 in 1991 from Doo Sung.    Doo Sung also testified to the

existence of these loans.    Their testimony regarding the $30,000

loan in 1990 was corroborated by a copy of Doo Sung's checking

account statement for a period ended October 25, 1990, that

showed that a check in the amount of $30,000 had cleared the bank

on October 22, 1990.   Yoon's and Doo Sung's testimony regarding
                               - 19 -

the $30,000 loan and the $3,000 loan is neither incredible nor

controverted.    Petitioners' net worth for 1990 and 1991 must be

adjusted to reflect these increased liabilities.

     Petitioner also testified that he borrowed $40,000, in

addition to the $80,000 allowed by respondent, from Gilpin.     He

testified that he did not sign a promissory note for either the

$80,000 loan or the $40,000 loan from Gilpin.   Gilpin was not

called to testify at trial.   The evidence presented regarding the

$40,000 loan is sparse, ambiguous, and consists only of:

canceled checks reflecting $109,320 in 1991 in payments to

Gilpin; a letter stating that the checks represent the repayment

of the $80,000 loan with interest; and a copy of a receipt from a

title company indicating a $40,000 deposit from Gilpin to an

account for the purchase of 515 Stanton Street.

     Petitioners present two alternative arguments regarding the

alleged $40,000 loan from Gilpin.    First, petitioners argue that

their liabilities should be increased by $40,000 as of

December 31, 1989, and reduced as of December 31, 1990, by

documented payments.   In the alternative, if the $40,000 is not

recognized as a liability, petitioners ask that the excess over

$80,000 that petitioners paid to Gilpin be treated as an interest

deduction in 1991.   In any event, petitioners argue that the

excess payments were not personal living expenses as determined

by respondent.
                                - 20 -

     We are not persuaded that an additional $40,000 debt to

Gilpin existed.    We conclude, however, that petitioners did have

an interest obligation to Gilpin on the $80,000 debt and paid

interest in 1991.    Petitioners are entitled to an interest

deduction of $29,320 in 1991 relating to property they owned at

519 Stanton Street.    No other payments have been established to

be interest during that year.

     Petitioners argue that at least six additional loans in

amounts ranging from $5,000 to $15,000 existed during the years

in issue.    The only evidence of these loans is petitioners'

testimony at trial as to the amount and approximate date of each

alleged loan.    Petitioner does not claim that any promissory

notes were issued, that any interest was charged, or that any

portion of any of the alleged loans has been repaid.     Yoon and

Doo Sung testified that Korean custom dictates that no promissory

notes are executed to represent indebtedness because a friend's

word is enough of a promise to repay.     Petitioners are required,

however, to establish by a preponderance of the evidence that the

loans existed.    Yoon's uncorroborated testimony as to the

existence of additional loans is insufficient.     See Wood v.

Commissioner, 338 F.2d 602, 605 (9th Cir. 1964), affg. 41 T.C.

593 (1964).

     2.     Asset Balances

     a.     Bank account balances.   Petitioners contend that

respondent erred in failing to reduce yearend bank balances by
                               - 21 -

outstanding checks.   Respondent argues that she has been

consistent in her treatment of the outstanding checks over the

years in issue and that, in any event, the treatment sought by

petitioners would result in a "wash".

     Generally, bank balances are reduced by outstanding checks.

See Lanier v. Commissioner, T.C. Memo. 1966-14.    However, we

cannot be certain that all outstanding checks have been

identified for each of the years in issue.    At trial, both

Caufield and the revenue agent testified that the check registers

and all canceled checks and bank statements from petitioners'

various accounts were not presented during the examination of

petitioners' returns.    Furthermore, petitioners have not

presented evidence regarding any outstanding checks as of

December 31, 1988.    This information would be necessary for

consistency in the net worth computations.    Respondent's

determination of petitioners' bank account balances will be

sustained.

     Petitioners also argue that respondent erred in including

the bank accounts of petitioners' children in petitioners' net

worth.   At trial, the revenue agent testified that it appeared

that deposits into the children's accounts included business

receipts.    Yoon testified at trial that neither of petitioners

deposited business money into their children's bank accounts and

that family gifts generally made up any deposits into the

accounts.    Yoon also testified, however, that his wife received a
                                 - 22 -

salary from L.A. Trading and that he did not know what she did

with those paychecks.    Petitioners have not persuaded us that

petitioners' own funds were not deposited into these accounts.

Respondent's determination that petitioners' children's bank

accounts are included in petitioners' net worth will be

sustained.

     b.   1980 Buick.    Petitioners contend that respondent failed

to include in their net worth a Buick they purchased in 1980.

Yoon testified at trial that the Buick cost $10,000 when he

purchased it in 1980.    Petitioners traded the Buick when they

purchased their 1989 Isuzu.    Respondent has not argued that the

Buick was not owned by petitioners in 1988 and has conceded that

petitioners' 1989 net worth should be reduced by $800, the trade-

in value of the Buick.

     In making use of the net worth method, actual cost, not fair

market value, is to be used.     See Kelley v. Commissioner, T.C.

Memo. 1964-267.    We conclude that petitioners' net worth on

December 31, 1988, should be increased by $10,000 and that

petitioners' net worth on December 31, 1989, should be decreased

by $10,000 to reflect the ownership and subsequent sale of the

Buick.

     c.   JKY capital account.    Petitioners argue that respondent

erred in three ways in the calculation of petitioners' JKY

capital account.
                               - 23 -

     First, petitioners argue that respondent did not subtract

outstanding checks from the balances of the bank accounts

transferred to JKY.   We incorporate herein the above discussion

of that argument.

     Second, petitioners argue that the actual transfer to JKY

consisted of $22,481.66 of business assets and $8,601.08 of

depreciation, not $33,546 of business assets and $17,114 of

depreciation as respondent determined.    Petitioners offered an

undated document prepared by Caufield entitled "S Corporation 351

Transfer" as evidence that respondent's calculation of assets and

depreciation was incorrect.    No supporting documents were

presented.   Caufield testified at trial that this document

represented his initial computation of petitioners' section 351

transfer.    He noted that at least one of the liabilities

represented on the document was in fact paid by the date of the

transfer and thus its inclusion was an error.    Caufield also

testified that his calculation of the category "Fixed Assets",

unlike respondent's, did not include a 1982 Chevrolet van that

was sold by petitioners prior to the section 351 transfer.    Yoon

did not testify about the transfer of assets to JKY.    Other than

Caufield's testimony that the 1982 Chevrolet van was not included

in his calculation of fixed assets, we are provided with nothing

other than a summary with preliminary numbers and no support or

explanation.   Petitioners have not presented sufficient evidence
                                - 24 -

that respondent's computation of the assets and depreciation

transferred to JKY was in error.

     Finally, petitioners argue that JKY assumed certain payroll

taxes that should reduce petitioners' capital account balance for

each of the years in issue.    Caufield testified that JKY assumed

various payroll tax liabilities as part of the section 351

transfer.   These payroll taxes were included on Caufield's "S

Corporation 351 Transfer".    Respondent determined that JKY did

not assume these liabilities.    By Caufield's own admission at

trial, the "S Corporation 351 Transfer" represented his initial

computation.   Petitioners have not provided any evidence, through

Yoon's testimony or canceled checks, of JKY's assumption or

payment of these payroll tax liabilities.    Respondent's

determination that JKY did not assume various payroll tax

liabilities will be sustained.

     3.   Personal Living Expenses

     Petitioners argue that their personal living expenses for

1989 were less than those calculated by respondent.    Petitioners

claim that certain expenditures, mainly life insurance payments

and income tax payments, were incurred in 1990 and not in 1989.

This, petitioners claim, would make a difference because

respondent used a discounted 1990 figure to determine

petitioners' 1989 personal living expenses.    If only the

recurring items of expense were included for both years before
                              - 25 -

the discount was applied, a lesser amount would be arrived at for

1989.

     Petitioners have chosen to rely on a discounted 1990 figure

less the above-mentioned expenses instead of producing their

books and records so that a calculation of actual personal living

expenses for 1989 could be made.   Petitioners have offered no

explanation for their failure to produce any books and records

for 1989.   Without proof of actual personal living expenses for

1989, we cannot conclude that respondent's determination of

petitioners' personal living expenses for 1989 is incorrect or

unreasonable.

     Petitioners also object to respondent's use of a "plugged"

figure of $17,411 in her computation of personal living expenses

for 1990.   The revenue agent testified that this amount

represented the difference between the bank account balances and

the analysis of personal living expenses for 1990 provided to

respondent by petitioners.   The revenue agent also testified that

petitioners did not provide any explanations or canceled checks

to support any other treatment of this amount.   Petitioners also

failed at trial to offer any explanation of the difference

between the bank account balances and petitioners' calculation of

their personal living expenses.    Respondent's determination that

petitioners' personal living expenses for 1990 include $17,411 of

unexplained expenses will be sustained.
                              - 26 -

     Petitioners also argue that respondent erred in determining

that other unidentified expenses were personal living expenses.

Petitioners have failed to identify the specific instances when

this occurred and have failed to offer any proof that any

additional unidentified expenses determined by respondent to be

personal living expenses were not such.    Petitioners have not

proven by a preponderance of evidence that additional adjustments

are warranted to respondent's calculation of their personal

living expenses for the years in issue.    Respondent's

determination that unidentified expenses were personal living

expenses will be sustained.

     4.   JKY Income

     Respondent now contends that she understated JKY's total

receipts for 1991 by $36,455 because certain deposits were not

included in the reconciliation of gross receipts.    Respondent has

conceded that she understated sales returns/chargebacks in 1991

by $32,039 in her initial determination.    The correct amount of

sales returns chargebacks for 1991 is $140,614.37.    Respondent

asks us to sustain her original Form 1120S pass-through

adjustment for 1991 even though these computational adjustments

respondent now seeks result in an increased deficiency.

Petitioners contend that respondent has raised a new issue.    This

issue involves a new matter because the evidence necessary for

resolution of it differs from that relevant to the original
                              - 27 -

determination.   Respondent bears the burden of proof as to any

new matter.   Rule 142(a).

     Respondent did not question the revenue agent regarding this

alleged error in the notice of deficiency.   Respondent presented

us with proof of bank deposits, constituting gross receipts, into

account number 62-00931 that she alleges were not included in the

notice of deficiency.   Petitioners agree that respondent has

produced sufficient proof of this account balance, but they argue

that this proof is not sufficient proof that this amount was

omitted from respondent's determination in the notice of

deficiency.   Respondent has attempted to bolster her position by

introducing a supporting schedule, a bank deposits account

summary, and a bank deposit detail prepared by the revenue agent

during the examination of petitioners' returns to show that this

account balance was omitted from the determination in the notice

of deficiency.

     We have looked to these workpapers not for the truth of the

facts and figures contained therein but for the presence or

absence of deposits into account No. 62-00931.   Upon examination

of the revenue agent's schedules, we can see that no deposits

were included for account No. 62-00931 for 1991 in calculations

on certain schedules.   However, many of the schedules have

handwritten notations and various corrections that we cannot

reconcile with respondent's argument.   Because of these apparent

revisions, we cannot be certain that these schedules reflect the
                               - 28 -

final product of the revenue agent, especially in light of her

failure to testify regarding this omission.    Respondent has

failed to prove that she understated JKY's gross receipts for

1991 in making her determination.

     At trial, Yoon also testified as to the existence of certain

liabilities to his suppliers resulting from cash advances

received from the suppliers.    These liabilities, petitioners

claim, increase JKY's nontaxable receipts.    Respondent allowed

$129,530 of other nontaxable receipts.

     Petitioners have presented Yoon's testimony and several

deposit slips with the names of JKY's Korean-owned suppliers

listed next to amounts of the checks deposited as evidence of

these debts.    Yoon testified that no notes were executed, that no

interest was charged, and that he could not recall when he repaid

the debts.    Yoon also testified that JKY had outstanding credit

balances with the companies that loaned him money.    At trial,

respondent questioned why the suppliers would have loaned JKY

cash instead of reducing the outstanding account balances.      Yoon

responded that there was a need for money at the time.    Because

JKY was a big customer of these suppliers and Yoon often

entertained the suppliers to garner favor, it is not incredible

that suppliers would advance to JKY relatively small amounts of

cash (when compared to the purchases JKY was making from the

suppliers).    JKY's nontaxable receipts for 1991 should be
                               - 29 -

increased by $22,000 to reflect the advances from suppliers

claimed by petitioners.

     Petitioners now contend that credit card charges, in

addition to those allowed by respondent, are deductible as

business expenses.   Respondent treated all payments on personal

credit cards as personal living expenses.     Petitioners argue that

it was unreasonable for respondent to treat the payments in that

manner.   Petitioners claim that they are entitled to additional

business expense deductions of $17,774.94 on JKY's 1990 return

and $26,788.87 on JKY's 1991 return for expenses charged to

personal credit cards.    Petitioners have offered schedules of

credit card charges prepared by Caufield that categorize each

credit card expenditure.    The underlying credit card statements

are not part of the record in this case.     Also, the schedules

show that certain statements were not available at the time the

schedule was created.    Caufield testified at trial that he

prepared the schedules and consulted Yoon only when Caufield was

unclear as to the classification of a charge as business or

personal.

     Numerous items claimed as business deductions by petitioners

appear to be for travel and entertainment, i.e., restaurant

charges and airline charges.    Petitioners claim that 100 percent

of these expenses is deductible, ignoring the 80-percent limit on

deductibility under section 274(n).     Furthermore, to prove

entitlement to deductions for travel and entertainment expenses,
                              - 30 -

the taxpayer must meet the specific substantiation requirements

of section 274, including the date, time, place, amount, and

business purpose of the expense as well as the business

relationship of those entertained by the taxpayer.     Meridian Wood

Products Co. v. United States, 725 F.2d 1183, 1188 (9th Cir.

1984).   Section 274 precludes our making an estimate, under Cohan

v. Commissioner, 39 F.2d 540 (2d Cir. 1930), with respect to

travel and entertainment expenses.     See, e.g., Meridian Wood

Products Co. v. United States, supra at 1188-1190.     Even if

section 274 were not applicable, there is insufficient evidence

here to support an estimate of petitioners' claimed travel and

entertainment expenses.   There is also insufficient evidence to

support an estimate under Cohan v. Commissioner, supra, for the

remaining claimed deductions that fall outside of the

substantiation requirements of section 274, such as business

repair expenses.

     Petitioners have not indicated which expenditures have

already been deducted on JKY's 1990 and 1991 returns.     From the

evidence before us, we cannot be certain that any of the claimed

expenditures were actually for business purposes.     Yoon did not

testify as to the purpose of the expenditures.     Also, from his

testimony, it appears that Caufield, not Yoon, classified most of

the expenditures on the schedules.     We have been provided only

with the amount of the alleged charges and the name of the place

where the credit purchase was allegedly made.     For the foregoing
                              - 31 -

reasons, Caufield's schedules are not reliable.    Petitioners have

failed to prove by a preponderance of the evidence JKY's

entitlement to additional deductions.    Respondent's determination

that charges on personal credit cards are to be treated as

personal living expenses will be sustained.

Conclusion

     We have examined the arguments of petitioners that

respondent's determination is arbitrary and erroneous and have

determined that they are without merit.

     We also conclude that petitioners' argument that respondent

has failed to establish a likely source of income or to conduct a

reasonable investigation of leads to negate the existence of

nontaxable sources of income is without merit.    Petitioners'

claims of nontaxable sources were the alleged loans from friends

and relatives and advances to JKY by suppliers.    Respondent

considered those claims made by petitioners during the

examination, included some of the claimed liabilities in her net

worth determinations, and determined others were not valid.

Where relevant leads are not forthcoming from petitioners,

respondent is not required to negate every possible source of

income.   Holland v. United States, 348 U.S. 121, 137 (1954).

While we have adjusted the net worth determination to include

other liabilities, such corrections do not invalidate

respondent's entire determination.     Hoffman v. Commissioner, 298

F.2d 784, 788 (3d Cir. 1962), affg. in part T.C. Memo. 1960-160.
                               - 32 -

Section 6651(a)(1) Addition to Tax

     Respondent also determined that petitioners are liable for

the section 6651(a)(1) addition to tax for 1991.     Section

6651(a)(1) imposes an addition to tax for failure to file timely

a return, unless the taxpayer establishes that the failure did

not result from “willful neglect” and that the failure was due to

“reasonable cause”.   The addition to tax equals 5 percent of the

tax required to be shown on the return for the first month, with

an additional 5 percent for each additional month or fraction of

a month during which the failure to file continues, not to exceed

a maximum of 25 percent.    Sec. 6651(a)(1).

     “Willful neglect” has been interpreted to mean a conscious,

intentional failure or reckless indifference.      United States v.

Boyle, 469 U.S. 241, 245-246 (1985).     “Reasonable cause” requires

the taxpayers to demonstrate that they exercised ordinary

business care and prudence and were nonetheless unable to file a

return within the prescribed time.      Id. at 246; sec. 301.6651-

1(c)(1), Proced. & Admin. Regs.

     Petitioners bear the burden of proving that respondent’s

determination is incorrect.    Rule 142(a); Cluck v. Commissioner,

105 T.C. 324, 339 (1995).    Petitioners failed to offer any

evidence or explanation regarding the late filing of their 1991

return.   Thus, respondent’s determination that petitioners are

liable for the section 6651(a)(1) addition to tax for 1991 will

be sustained.
                              - 33 -

Section 6662(a) Accuracy-Related Penalty

     Section 6662(a) imposes a penalty in an amount equal to

20 percent of the underpayment of tax attributable to one or more

of the items set forth in section 6662(b).   Respondent asserts

that the entire underpayment of petitioners’ tax was due to

negligence or intentional disregard of rules or regulations, sec.

6662(b)(1), or a substantial understatement, sec. 6662(b)(2).

Because respondent raised the accuracy-related penalty in her

answer, respondent bears the burden of proof on this issue.    Rule

142(a).

     “Negligence” includes a failure to make a reasonable attempt

to comply with the provisions of the internal revenue laws.    Sec.

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

includes any careless, reckless, or intentional disregard of

rules or regulations.   Sec. 6662(c); sec. 1.6662-3(b)(2), Income

Tax Regs.

     Petitioners' failure to maintain and to produce reliable

records of their financial transactions and taxable income

supports a conclusion of negligence.   Crocker v. Commissioner, 92

T.C. 899, 917 (1989); Schroeder v. Commissioner, 40 T.C. 30, 34

(1963).   They cannot avoid the penalty based on reliance on their

tax preparers because they did not provide the preparers with

sufficient and accurate information to prepare their returns.

Metra Chem Corp. v. Commissioner, 88 T.C. 654, 662 (1987).     The

evidence justifies the penalty for negligence.
                        - 34 -

To reflect the foregoing and concessions by respondent,

                                   Decision will be entered

                              under Rule 155.
