                                T.C. Memo. 2020-7



                         UNITED STATES TAX COURT



          WILFREDO E. RIVERA AND MARIA T. RIVERA, Petitioners v.
            COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 22285-16.                          Filed January 13, 2020.



      Joseph M. Bray and Tyson R. Smith, for petitioners.

      Cameron W. Carr and Thomas R. Mackinson, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


      VASQUEZ, Judge: Respondent determined deficiencies in petitioners’

Federal income tax and section 6662(a)1 accuracy-related penalties as follows:


      1
         All section references are to the Internal Revenue Code (Code) in effect at
all relevant times, and all Rule references are to the Tax Court Rules of Practice
and Procedure, unless otherwise indicated. All monetary amounts have been
                                                                       (continued...)
                                        -2-

[*2]                                                 Penalty
                     Year         Deficiency       sec. 6662(a)
                     2013          $49,303               $9,860
                     2014          122,547               24,509

       After concessions,2 the issues for decision are whether: (1) petitioners’

partnership received and failed to report gross receipts on Forms 1065, U.S.

Return of Partnership Income (partnership returns), (2) the partnership is entitled

to certain deductions claimed on the partnership returns, and (3) petitioners are

liable for section 6662(a) accuracy-related penalties.

                                 FINDINGS OF FACT

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

stipulation of facts, first supplemental stipulation of facts, second supplemental

stipulation of facts, and accompanying exhibits are incorporated herein by this

reference. Petitioners resided in California when they timely filed their petition.



       1
      (...continued)
rounded to the nearest dollar.
       2
         Respondent concedes that petitioners’ taxable income for 2014 does not
include a pension distribution of $99,898 and that petitioners are not liable for a
10% additional tax on that distribution. Petitioners concede all noncomputational
adjustments in the notice of deficiency except for those to gross receipts, “other
deductions”, and the imposition of sec. 6662(a) penalties. The parties also made
partial concessions, which we address in the body of this opinion.
                                            -3-

[*3] I.         Background

          Petitioners were born and raised in the Philippines and immigrated to the

United States in 1983. Petitioner husband was a laboratory assistant, and

petitioner wife was a registered nurse during the years at issue. Petitioners do not

have any training in taxation or accounting.

          Jet Travel International (JTI) is a travel agency that petitioners began

operating as a flowthrough partnership in 2007. Petitioners were each 50%

owners of JTI3 and reported losses therefrom on Schedules E, Supplemental

Income and Loss, for the years at issue. Petitioners, on behalf of JTI, purchased

travel tickets for resale using their American Express credit card. JTI’s clients

purchased the travel tickets by cash or check. In connection with the operation of

JTI, petitioners incurred bank charges on JTI’s behalf.

          During the years at issue petitioners were also independent business owners

(IBOs) in American Communication Network, Inc. (ACN), a multilevel marketing

company that focuses on selling telecommunications services. In connection with

          3
        Thus, for the years at issue, JTI had 10 or fewer partners, each of whom
was an individual. As there is no indication that an election was made under sec.
6231(a)(1)(B)(ii), JTI was a small partnership under sec. 6231(a)(1)(B), and secs.
6221 to 6234 do not apply. Instead, respondent’s adjustments to JTI’s income and
expenses are to be decided in this proceeding. See New Phoenix Sunrise Corp. v.
Commissioner, 132 T.C. 161, 173 n.3 (2009) (citing Wadsworth v. Commissioner,
T.C. Memo. 2007-46), aff’d, 408 F. App’x 908 (6th Cir. 2010).
                                        -4-

[*4] their business of selling ACN services, petitioners attended several ACN

conventions and incurred expenses for ACN-related fees, dues, and subscriptions.

      Petitioners owned a 2007 Lexus ES 350 during the years at issue. They

used the automobile to travel to various ACN IBO presentations in the San

Francisco Bay area, Los Angeles, San Diego, Sacramento, and Nevada. At those

locations petitioners hosted private business receptions to recruit individuals to

join ACN.

      During 2013 and 2014 JTI had a business economy checking account with

Bank of America. Petitioners also maintained two joint accounts at Bank of

America in their own names and one account at Chase in petitioner wife’s name in

2013. In 2014 petitioners continued to maintain one of the two joint accounts at

Bank of America and the Chase account. Petitioner wife deposited her wage

income into the Chase account.

      In 2013 petitioners cashed a check for $160, which was reflected as a

“Counter Credit” in petitioners’ records. Petitioner husband, on JTI’s behalf,

received this check from a client as reimbursement for the payment of a rebooking

penalty.
                                        -5-

[*5] II.     Tax Reporting, Examination, and Notice of Deficiency

       In 2010, at the recommendation of petitioner husband’s coworker,

petitioners hired Roosevelt L. Drummer to prepare their Federal tax returns. Mr.

Drummer had a physical office location and held himself out as a former revenue

agent (RA) for the Internal Revenue Service (IRS) and an expert in business and

taxation.

       Petitioners provided Mr. Drummer with copies of their Forms W-2, Wage

and Tax Statement, and other documents. Mr. Drummer prepared petitioners’

joint Federal income tax returns for the years at issue; he also prepared JTI’s

partnership returns on the basis of the information that petitioners gave him. For

both years at issue JTI treated ACN as a component of its business, reporting the

income and expenses of both JTI and ACN on its partnership returns.4

       Mr. Drummer advised petitioners that they could permissibly deduct their

daughter’s college tuition if they paid it through their daughter’s S corporation.

Trusting what they understood to be Mr. Drummer’s experience as a former IRS

RA, petitioners followed his advice. The details of the arrangement are not

entirely clear. What we do know is that Mr. Drummer helped organize the

       4
        Neither party contends that the ACN’s reported income and expenses
should be moved to Schedules C, Profit or Loss From Business, on petitioners’
income tax returns.
                                          -6-

[*6] S corporation, to which JTI wrote checks. The proceeds of the checks were

ultimately used to pay petitioners’ daughter’s tuition.5 JTI deducted its payments

to the S corporation as “outside services” on its 2013 and 2014 partnership

returns.6 Mr. Drummer assured petitioners that this deduction was proper, and

petitioners believed him.

      On the 2013 partnership return JTI reported gross receipts of $25,639 and

claimed various deductions, including $119,815 for “other deductions”.7 On the

2014 partnership return JTI reported gross income of $15,961 and claimed “other

deductions” of $120,501.8 JTI, which purchased travel tickets for resale, did not

report any cost of goods sold on either the 2013 or 2014 partnership return.

      Petitioners’ and JTI’s returns were selected for examination and assigned to

RA Eddie Wong. Petitioners provided RA Wong with their and JTI’s Bank of



      5
          The S corporation’s tax returns for the years at issue are not in the record.
      6
         The record does not establish that the S corporation provided JTI any
services.
      7
        For 2013 JTI’s “other deductions” comprised, among other things,
“outside services” of $40,862. Petitioners concede that this expenditure was a
nondeductible college tuition payment.
      8
        For 2014 JTI’s “other deductions” comprised, among other things,
“outside services” of $4,615. Petitioners concede that this expenditure was a
nondeductible college tuition payment.
                                        -7-

[*7] America account statements. After petitioners were unable to identify the

sources of several deposits, RA Wong summoned and received records for the

Bank of America accounts. He prepared a bank deposits analysis for each year at

issue. He did not know that petitioner wife maintained an account at Chase;

accordingly, he did not include the account in his bank deposits analyses.9

      Using the summoned records, RA Wong (1) totaled all deposits into

petitioners’ and JTI’s Bank of America accounts, (2) subtracted out deposits

determined to be nontaxable, including interaccount transfers and refunds, and

deposits from nontaxable sources, (3) subtracted the amounts of income that

petitioners and JTI had reported on their tax returns, and (4) determined the

resulting amounts to be JTI’s unreported gross receipts, which in turn he

determined to be items entering into the calculation of petitioners’ taxable income.

      RA Wong determined that JTI had unreported gross receipts of $284,521

and $383,002 for 2013 and 2014, respectively.10 In a bank deposits analysis that



      9
        RA Wong, who replaced another RA during the pendency of the audit, did
not request petitioners’ bank statements in writing. The record does not indicate,
and respondent does not allege, that petitioners intentionally concealed the
existence of the Chase account.
      10
        RA Wong also determined that JTI had unreported “purchases” of
$249,400 and $277,430 for 2013 and 2014, respectively. For each year at issue,
RA Wong allowed JTI an additional deduction for the purchases.
                                          -8-

[*8] petitioners prepared and provided to RA Wong during the audit, petitioners

calculated the same amounts of unreported gross receipts as RA Wong.

      Respondent issued petitioners a notice of deficiency for the years at issue

reflecting RA Wong’s determinations of unreported gross receipts. The deficiency

notice also disallowed several expense deductions claimed on the 2013 and 2014

partnership returns and determined that petitioners were liable for section 6662(a)

accuracy-related penalties for the years at issue.

      As stated supra note 2, petitioners concede the disallowance of all

partnership deductions except for those to “other deductions”. Petitioners also

dispute their liability for the accuracy-related penalties.

                                      OPINION

I.    Unreported Income

      As a general rule, the Commissioner’s determinations in a notice of

deficiency are presumed correct, and the taxpayer bears the burden of proving that
                                        -9-

[*9] the determinations are incorrect.11 Rule 142(a); Welch v. Helvering, 290 U.S.

111, 115 (1933).

      In the Court of Appeals for the Ninth Circuit, to which an appeal of this

case presumably would lie absent a stipulation to the contrary, see sec.

7482(b)(1)(A), (2), the presumption of correctness does not attach in cases

involving unreported income unless the Commissioner first establishes an

evidentiary foundation linking the taxpayer to the alleged income-producing

activity, see Weimerskirch v. Commissioner, 596 F.2d 358, 361-362 (9th Cir.

1979), rev’g 67 T.C. 672 (1977). The requisite evidentiary foundation is minimal

and need not include direct evidence. See Rapp v. Commissioner, 774 F.2d 932,

935 (9th Cir. 1985); Banister v. Commissioner, T.C. Memo. 2008-201, aff’d, 418

F. App’x 637 (9th Cir. 2011).

      Once the Commissioner produces evidence linking the taxpayer to an

income-producing activity, the burden shifts to the taxpayer “to rebut the


      11
          Sec. 7491(a) provides that if, in any court proceeding, a taxpayer
introduces credible evidence with respect to any factual issue relevant to
ascertaining the liability of the taxpayer for any tax imposed by subtit. A or B and
meets other prerequisites, the Commissioner shall have the burden of proof with
respect to that issue. See Higbee v. Commissioner, 116 T.C. 438, 440-441 (2001).
However, petitioners have neither claimed nor shown that they satisfied the
requirements of sec. 7491(a) to shift the burden of proof to respondent.
Accordingly, petitioners bear the burden of proof. See Rule 142(a).
                                         - 10 -

[*10] presumption of correctness of * * * [the Commissioner’s] deficiency

determination by establishing by a preponderance of the evidence that the

deficiency determination is arbitrary or erroneous.” Petzoldt v. Commissioner, 92

T.C. 661, 689 (1989); see also Hardy v. Commissioner, 181 F.3d 1002, 1004 (9th

Cir. 1999), aff’g, T.C. Memo. 1997-97.

      Every individual liable for tax is required to maintain books and records

sufficient to establish the amount of his or her taxable income. Sec. 6001; DiLeo

v. Commissioner, 96 T.C. 858, 867 (1991), aff’d, 959 F.2d 16 (2d Cir. 1992). As

petitioners could not identify the sources of most deposits shown on their bank

statements, they failed to produce adequate records for respondent to calculate

their taxable income flowing from JTI.

      Where a taxpayer fails to maintain or produce adequate books and records,

the Commissioner is authorized to compute the taxpayer’s taxable income by any

method that clearly, in the Commissioner’s opinion, reflects income. Sec. 446(b);

Holland v. United States, 348 U.S. 121 (1954); Webb v. Commissioner, 394 F.2d

366, 371-372 (5th Cir. 1968), aff’g T.C. Memo. 1966-81. The reconstruction of

income need only be reasonable in the light of all surrounding facts and

circumstances. See Giddio v. Commissioner, 54 T.C. 1530, 1533 (1970). The

Commissioner is given latitude in determining which method of reconstruction to
                                      - 11 -

[*11] apply when a taxpayer fails to maintain records. Petzoldt v. Commissioner,

92 T.C. at 693.

      Respondent employed the bank deposits method of proof to reconstruct

petitioners’ taxable income flowing from JTI. The acceptability of this method of

proof is well established. DiLeo v. Commissioner, 96 T.C. at 867; Estate of

Mason v. Commissioner, 64 T.C. 651, 656 (1975), aff’d, 566 F.2d 2 (6th Cir.

1977). Bank deposits are prima facie evidence of income. Tokarski v.

Commissioner, 87 T.C. 74, 77 (1986); Estate of Mason v. Commissioner, 64 T.C.

at 656-657. When using the bank deposits method, the Commissioner is not

required to show that each deposit or part thereof constitutes income, Gemma v.

Commissioner, 46 T.C. 821, 833 (1966), or prove a likely source, Clayton v.

Commissioner, 102 T.C. 632, 645 (1994); Estate of Mason v. Commissioner, 64

T.C. at 657. Unless the nontaxable nature of deposits is established, gross income

includes deposits to bank accounts where the taxpayer has dominion and control

of the funds. See Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431

(1955); Davis v. United States, 226 F.2d 331, 334-335 (6th Cir. 1955); Manzoli v.

Commissioner, T.C. Memo. 1988-299, aff’d, 904 F.2d 101 (1st Cir. 1990).

      Respondent performed a bank deposits analysis for each year at issue and

determined that JTI’s gross receipts for 2013 and 2014 should be adjusted by
                                       - 12 -

[*12] $284,521 and $383,002, respectively. By reconstructing JTI’s gross receipts

using the bank deposits method and demonstrating that petitioners used the bank

accounts for the business, respondent established the requisite minimal foundation

linking petitioners with an income-producing activity. Accordingly, petitioners

bear the burden of proving that respondent’s deficiency determinations are

arbitrary or erroneous.

      Petitioners, who agreed with RA Wong’s bank deposits analyses during the

audit, now argue that the analyses contain several mistakes. They have met their

burden with respect to only a handful of transactions.

      For 2013 respondent determined a $160 check to be taxable income.

However, petitioner husband credibly testified that he received the funds on behalf

of JTI as reimbursement for the payment of a rebooking penalty. Generally, gross

income does not include such reimbursements for expenses a taxpayer pays on

behalf of another. Gray v. Commissioner, 10 T.C. 590, 596-597 (1948); Fishman

v. Commissioner, T.C. Memo. 2011-102, slip op. at 18. We therefore find that the

$160 check payment is not includable in JTI’s gross receipts.12




      12
         We note that respondent allowed JTI an additional deduction for
unreported “purchases” for 2013. Respondent does not contend that this
deduction includes the $160 payment.
                                        - 13 -

[*13] With respect to 2014, respondent concedes on brief that the following

deposits are not includable in JTI’s gross receipts: (1) a Federal income tax refund

of $25,870 for the 2013 tax year and (2) transfers of petitioner wife’s salary

deposits from the Chase account totaling $46,000.

      Other than those transactions, however, petitioners have not provided any

evidence that the remaining deposits respondent identified as income are

nontaxable. Therefore, we conclude that the remaining deposits for 2013 and

2014 are taxable income.

      Petitioners argue that respondent’s determination of unreported gross

receipts should be set aside because RA Wong failed to subtract the above-

described nontaxable deposits from his bank deposits analyses. We disagree.

      It is true that respondent incorrectly concluded that some bank deposits,

such as the $160 check and the $25,870 Federal income tax refund, were income.

However, courts recognize that some errors are unavoidable when an indirect

method is used to reconstruct income, especially where (as here) the taxpayer

failed to maintain adequate records. See United States v. Stonehill, 702 F.2d

1288, 1295-1296 (9th Cir. 1983); see also Canatella v. Commissioner, T.C. Memo.

2017-124, at *12-*13.
                                       - 14 -

[*14] Given petitioners’ failure to maintain adequate records and their inability to

identify the sources of most deposits, respondent’s reconstruction of income was

reasonable in the light of the surrounding facts and circumstances. See Giddio v.

Commissioner, 54 T.C. at 1533. The record establishes that RA Wong made an

effort to determine which deposits were attributable to nontaxable sources (and

indeed, he determined that some deposits were attributable to nontaxable sources).

      Accordingly, we conclude that JTI had unreported gross receipts of

$284,361 and $311,132 for 2013 and 2014, respectively.

II.   Substantiation of Partnership Deductions

      We next address whether JTI is entitled to the “other deductions” it claimed

for the years at issue. Deductions are a matter of legislative grace, and taxpayers

generally bear the burden of proving that they are entitled to any deductions

claimed. Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992);

New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).

      Section 162(a) generally allows a deduction for ordinary and necessary

expenses paid or incurred during the taxable year in carrying on a trade or

business. Such expenses must be directly connected with or pertain to the

taxpayer’s trade or business. Sec. 1.162-1(a), Income Tax Regs. Generally, no

deduction is allowed for personal, living, or family expenses, nor is deduction
                                        - 15 -

[*15] proper for expenditures that are properly categorized as capital expenditures.

See secs. 262 and 263. The determination of whether an expenditure satisfies the

requirements of section 162 is a question of fact. Commissioner v. Heininger, 320

U.S. 467, 475 (1943).

      A taxpayer must maintain records sufficient to enable the Commissioner to

determine his correct tax liability. Sec. 6001; Higbee v. Commissioner, 116 T.C.

438, 440 (2001); sec. 1.6001-1(a), Income Tax Regs. A taxpayer must “keep such

permanent books of account or records * * * as are sufficient to establish the

amount of gross income, deductions, credits, or other matters required to be shown

by such person in any return of such tax or information.” Sec. 1.6001-1(a),

Income Tax Regs.

      If the taxpayer is able to establish that he paid or incurred a deductible

expense but is unable to substantiate the precise amount, the Court generally may

approximate the deductible amount, but only if the taxpayer presents sufficient

evidence to establish a rational basis for making the estimate (Cohan rule). See

Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930); see also Vanicek v.

Commissioner, 85 T.C. 731, 742-743 (1985). However, section 274(d) overrides

the Cohan rule with regard to certain expenses, including travel and certain listed

property, which if otherwise allowable are subject to strict substantiation rules.
                                       - 16 -

[*16] See Sanford v. Commissioner, 50 T.C. 823, 827 (1968), aff’d per curiam,

412 F.2d 201 (2d Cir. 1969); sec. 1.274-5T(a), Temporary Income Tax Regs., 50

Fed. Reg. 46014 (Nov. 6, 1985).

      Petitioners concede respondent’s adjustments to JTI’s deductions except for

those to other deductions, which respondent disallowed in full for lack of

substantiation.13 JTI’s other deductions comprise the following reported expenses:




      13
         At trial respondent argued in the alternative that the ACN-related
expenses on the partnership returns should be disallowed under sec. 183. This
argument was not set forth in either the notice of deficiency or the answer.
Respondent did not move to amend his pleadings or develop this argument on
brief. We deem the issue to not be before us. See Thiessen v. Commissioner, 146
T.C. 100, 106 (2016) (“[I]ssues and arguments not advanced on brief are
considered to be abandoned.”).
                               - 17 -

[*17]     Expense               2013     2014
        Accounting             $2,603    $2,403
        ACN convention           ---       214
        ACN fees                 ---     15,811
        Auto and truck         10,592    10,314
        Bank charges            2,304     1,404
        Dues and
         subscriptions           474       121
        Gifts                    601       300
        Global Empire            ---       376
        Legal and
         professional            ---       250
        “MEALS @ 100%”         17,671      ---
        Meals and
         entertainment          7,524     6,727
        Office expense         25,306    46,685
        Outside services1      40,862     4,615
        Parking and tolls          73      ---
        Postage                  306       151
        Printing                 ---         17
        Telephone               4,858     8,119
        Travel                  6,641     9,854
        Sales presentations      ---     11,198
        Supplies                 ---      1,942
         Total                119,815   120,501
                                        - 18 -

[*18] 1 As explained supra notes 7 and 8, petitioners have conceded that JTI is
not entitled to deductions for outside services.

      Our resolution of the substantiation issue turns on the applicable law and

our determination of the credibility of the evidence presented.

      A.     Expenses Not Subject to Section 274

             1.     Accounting Expenses

      JTI claimed deductions of $2,603 and $2,403, respectively, for accounting

expenses on its 2013 and 2014 partnership returns. Respondent argues that

petitioners neither substantiated the amounts claimed nor differentiated accounting

fees paid for the partnership returns and those paid for petitioners’ joint Federal

income tax returns. Accounting fees may be ordinary and necessary business

expenses which generally are deductible under section 162(a). Aref v.

Commissioner, T.C. Memo. 2009-118, slip op. at 10.

      Credit card statements stipulated by the parties reflect multiple payments

designated for tax, legal, and financial services during the years at issue: three

payments to “CNG Administrative” in 2013 totaling $7,162 and two more

payments to “CNG Administrative” in 2014 totaling $5,179. However, petitioners

did not assert at trial or on brief that these payments related to the accounting

expense deductions claimed on the JTI partnership returns. Furthermore, the
                                        - 19 -

[*19] record does not indicate what actual services petitioners or JTI received for

these payments. Accordingly, petitioners have not carried their burden of proof

with respect to accounting expenses, and we sustain respondent’s disallowance of

the deductions.

             2.    ACN Fees and ACN Convention

      JTI deducted “ACN INC FEES” of $15,811 and “ACN CONVENTION”

expenses of $214 on its 2014 partnership return. Respondent argues that

petitioners failed to substantiate these deductions.

      This court has previously found that fees paid to participate in multilevel

marketing arrangements may qualify as ordinary and necessary business expenses

under section 162(a). See Jones v. Commissioner, T.C. Memo. 2013-132, at *12,

*16-*17. Petitioner husband credibly testified that they were required to pay fees

to ACN regularly in order to participate in ACN’s multilevel marketing

arrangement. The credit card statements stipulated by the parties reflect frequent

recurring charges to ACN that total $15,620 during 2014, and we are persuaded

that those charges reflect the reported “ACN INC FEES”. We therefore find that

petitioners, on JTI’s behalf, paid ACN fees of $15,620 in 2014.

      The credit card statements also reveal that the $214 deduction for “ACN

Convention” expenses is comprised of two separate payments of $150 and $64 on
                                        - 20 -

[*20] June 20, 2014, and December 5, 2014, respectively. Petitioners’

handwritten annotation indicates that the expenses were incurred for “ACN

Magazine” and “ACN Folders”, respectively, and the credit card statements

indicate the payments were made to ACN Convention Supply.14 Given petitioner

husband’s credible testimony that petitioners attended ACN conventions in

connection with their business of selling ACN services, we find that these

expenses were ordinary and necessary business expenses.

      Accordingly, JTI is entitled to deductions of $15,620 and $214 for ACN

fees and ACN convention expenses, respectively, for 2014.

             3.     Bank Charges

      For 2013 and 2014, respectively, JTI claimed deductions of $2,304 and

$1,404 on its partnership returns for bank charges. Responded argues that

petitioners failed to substantiate these deductions.

      Petitioner husband credibly testified that the use of his American Express

card to purchase airline tickets for JTI’s clients resulted in bank charges in the

amounts claimed. On the basis of petitioner husband’s credible testimony, we find




      14
         Respondent did not object to the introduction of petitioners’ handwritten
notes as evidence.
                                       - 21 -

[*21] that JTI is entitled to deductions of $2,304 and $1,404 for bank charges for

2013 and 2014, respectively.

             4.    Dues and Subscriptions

      For 2013 and 2014, respectively, JTI claimed deductions of $474 and $121

for dues and subscriptions, which respondent disallowed in full. Petitioners

testified that these expenses represented monthly payments to ACN for use of a

“business assistant”, as well as a monthly subscription to ACN’s “Success

Magazine.” However, there is insufficient evidence in the record to establish that

JTI actually paid for these products in 2013 and 2014. Accordingly, we sustain

respondents’ disallowance of JTI’s deductions for dues and subscriptions for the

years at issue.

             5.    Global Empire

      On its 2014 partnership return JTI claimed a deduction of $376 for “Global

Empire”. Although petitioners’ credit card statements confirm that they paid $376

to Global Empire, Inc., in 2014, they did not explain the business purpose of the

expense. We therefore sustain respondent’s disallowance of this deduction.

             6.    Legal and Professional

      On its 2014 partnership return JTI claimed a deduction of $250 for legal and

professional expenses. While petitioners’ credit card statements reflect multiple
                                        - 22 -

[*22] payments for possible tax, legal, and financial services during 2014,

petitioners offered no testimony or other evidence linking the services to their

business activities with JTI. We therefore sustain respondent’s disallowance of

this deduction.

             7.    Office Expenses and Supplies

      For 2013 and 2014, respectively, JTI deducted office expenses of $25,306

and $46,685. In 2014 JTI also deducted $1,942 in expenses as “[s]upplies”.

Respondent argues that petitioners failed to substantiate these reported expenses.

      The cost of materials and supplies consumed and used in operations during

a taxable year is generally considered an ordinary and necessary expense of

conducting a business. See sec. 162(a); Bruns v. Commissioner, T.C. Memo.

2009-168, slip op. at 25; sec. 1.162-3, Income Tax Regs. Petitioner husband

credibly testified at trial that the claimed office expenses represented purchases for

printers and ink. However, petitioners’ credit card statements reflect total

payments of only $365 during 2013 at office supply retailers such as Office Depot,

the UPS Store, and Staples. The record does not indicate that JTI incurred rental

or other office-related expenses.
                                         - 23 -

[*23] Accordingly, JTI is entitled to a deduction of $365 for office expenses for

2013. We sustain respondent’s disallowance of the remaining $24,941 for 2013.

We also sustain respondent’s disallowance in full with respect to 2014.

             8.    Parking and Tolls

      JTI claimed a deduction of $73 for parking and tolls on its 2013 return.

Petitioners provided no testimony or other evidence to establish that the amounts

claimed were actually paid in 2013 or that these expenses were ordinary and

necessary business expenses. We therefore sustain respondent’s disallowance of

this deduction.

             9.    Postage and Printing

      For 2013 and 2014, respectively, JTI claimed deductions of $306 and $151

for postage; it also claimed a deduction of $17 for printing on its 2014 return.

Petitioners did not offer testimony or other evidence that the amounts claimed

were paid during the years at issue or that the reported expenses were ordinary and

necessary business expenses. Accordingly, we sustain respondent’s disallowance

of these deductions.

             10.   Sales Presentations

      JTI claimed a deduction of $11,198 for sales presentations on its 2014

return. Although petitioners testified that they traveled frequently to places like
                                        - 24 -

[*24] Los Angeles and San Diego for sales presentations related to their ACN

business, they did not provide evidence that the reported expenses were actually

paid in 2014. Accordingly, we sustain respondent’s disallowance of the

deduction.

              11.   Telephone

       For 2013 and 2014, respectively, JTI deducted telephone expenses of

$4,858 and $8,119 on its partnership returns. Respondent argues that these

deductions were properly disallowed for lack of substantiation. Telephone

expenses may be deductible under section 162(a) if the expenses incurred are

ordinary and necessary in carrying on a trade or business. Aref v. Commissioner,

slip op. at 11.

       At trial petitioner husband testified that the reported telephone expenses for

2013, totaling $4,858, were attributable to ACN and JTI. However, petitioners’

credit card statements reflect total telephone expenditures of only $2,476.

Because it is impossible to determine from the record which expenses related to

petitioners’ business and which to their personal use, we are unable to allow any

deduction for 2013 for telephone expenses. See Vanicek v. Commissioner, 85

T.C. at 742-743.
                                        - 25 -

[*25] With respect to tax year 2014, the credit card statements indicate that

petitioners paid five different telephone carriers that year. Two of those carriers

relate to petitioners’ JTI and ACN businesses. The record reflects that petitioners

paid $1,330 to ACN for digital phone services and $668 to Digitrain, Inc., which

petitioners indicated in a handwritten note was for a “phone purchased to qualify

IBO”. Petitioner husband credibly testified that petitioners were actively soliciting

sales with respect to their ACN venture.

      Accordingly, we find that petitioners (on behalf of JTI) paid $1,998 for

telephone services in 2014. JTI may deduct this amount for 2014.

      B.     Expenses Subject to Section 274

      Section 274(d) provides that no deduction is allowed with respect to travel,

entertainment, or listed property (as defined in section 280F(d)(4)) unless the

taxpayer substantiates by adequate records or by sufficient evidence corroborating

the taxpayer’s own statement (1) the amount of expense or item, (2) the time and

place of the travel, entertainment, or expense, (3) the business purpose of the

entertainment or expense, and (4) the business relationship to the taxpayer of the

person or persons entertained.

      To substantiate by adequate records, the taxpayer must provide (1) an

account book, log, or similar record prepared at or near the time of the expenditure
                                       - 26 -

[*26] and (2) documentary evidence, which together are sufficient to establish

each element of an expenditure. Sec. 1.274-5T(c)(2), Temporary Income Tax

Regs., 50 Fed. Reg. 46017 (Nov. 6, 1985). Documentary evidence includes

receipts, paid bills, or similar evidence. Sec. 1.274-5(c)(2)(iii), Income Tax Regs.

To substantiate by sufficient evidence corroborating the taxpayer’s own statement,

the taxpayer must establish each element by his or her own statement and by

documentary evidence or other direct evidence. Sec. 1.274-5T(c)(3)(i), Temporary

Income Tax Regs., 50 Fed. Reg. 46020 (Nov. 6, 1985). To establish the business

purpose of an expenditure, however, a taxpayer may corroborate his or her own

statement with circumstantial evidence. Id.

             1.    Auto and Truck

      For 2013 and 2014, respectively, JTI claimed deductions of $10,592 and

$10,314 for auto and truck expenses. Respondent disallowed deductions for these

expenses for lack of substantiation.

      A taxpayer may deduct the cost of operating an automobile under section

162 to the extent that it is used in a trade or business.15 Bruns v. Commissioner,


      15
          A taxpayer may deduct vehicle expenses by using either actual cost or the
standard mileage rate, provided he substantiates the amount of business mileage
and the time and purpose of each use. See sec. 1.274-5(j)(2), Income Tax Regs.;
Rev. Proc. 2010-51, 2010-51 I.R.B. 883.
                                        - 27 -

[*27] slip op. at 23. However, under section 262 no portion of the cost of

operating an automobile that is attributable to personal use is deductible. A

passenger vehicle is listed property under section 280F(d)(4) and is therefore

subject to the requirements of section 274(d).

      Petitioner husband testified that petitioners used their 2007 Lexus ES 350 to

travel to various ACN IBO presentations in the San Francisco Bay area, Los

Angeles, San Diego, Sacramento, and Nevada. However, petitioners produced no

mileage logs, receipts, or other documentation for these expenses as required by

section 274(d). In the absence of adequate records or other sufficient

corroborating evidence to establish each element of JTI’s claimed auto expense

deductions, we sustain respondent’s determination on this issue.

             2.    Gifts

      For 2013 and 2014, respectively, JTI claimed deductions of $601 and $300

for gifts. The cost of gifts may be an ordinary and necessary business expense if

the gifts are connected with the taxpayer’s opportunity to generate business

income. Bruns v. Commissioner, slip op. at 19. Deductions for gifts are subject to

the requirements of section 274(d).

      At trial petitioner husband testified that the gifts in question were birthday

presents. However, petitioners produced no evidence as to the business purpose of
                                        - 28 -

[*28] the gifts as required by section 274(d). We therefore sustain respondent’s

determination on this issue.

             3.    Meals and Entertainment

      On its 2013 return JTI claimed deductions of $17,671 and $7,524,

respectively, for “MEALS @ 100%” and meals and entertainment. For 2014 JTI

deducted $6,727 for meals and entertainment. Respondent argues that petitioners

have not substantiated these deductions.

      Petitioner husband testified that the reported meal expenditures were for

groceries, restaurants, and meetings at home conducted as part of the ACN

business. However, the credit card statements and accompanying information in

the record do not detail the time, place, and business relationship for each

expenditure. Additionally, the receipts do not indicate that the meals were

conducted for a business purpose.

      Because the record lacks adequate records or other sufficient evidence to

establish each element of their claimed meal and entertainment expense

deductions, we sustain respondent’s determination on this issue.
                                         - 29 -

[*29]          4.    Travel

         For 2013 and 2014, respectively, JTI claimed deductions of $6,641 and

$9,854 for travel. Respondent argues that petitioners have not substantiated these

reported expenses.

         Petitioner husband testified that they traveled four times a year to ACN

conventions. Additionally, the record includes cover pages, American Express

statements, and other hotel and airline receipts pertaining to petitioners’ 2014

travel expenses. However, the record does not contain any documentary evidence

or other direct or circumstantial evidence of the business purpose of each reported

travel expense.

         Because petitioners did not establish by adequate records or other sufficient

evidence the business purpose of their reported travel expenses, they have not met

the requirements of section 274(d). We sustain respondent’s determination on this

issue.

III.     Accuracy-Related Penalties

         Finally, we determine whether petitioners are liable for accuracy-related

penalties. Pursuant to section 6662(a) and (b)(1) and (2), a taxpayer may be liable

for a penalty of 20% on the portion of an underpayment of tax due to:

(1) negligence or disregard of rules or regulations or (2) a substantial
                                        - 30 -

[*30] understatement of income tax. “Negligence” is defined as any failure to

make a reasonable attempt to comply with the provisions of the Code; this

includes a failure to keep adequate books and records or to substantiate items

properly. Sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs. Negligence has

also been defined as the failure to exercise due care or the failure to do what a

reasonable person would do under the circumstances. See Allen v. Commissioner,

92 T.C. 1, 12 (1989), aff’d, 925 F.2d 348 (9th Cir. 1991); Neely v. Commissioner,

85 T.C. 934, 947 (1985). “Disregard” includes any careless, reckless, or

intentional disregard. Sec. 6662(c).

      “Understatement” means the excess of the amount of the tax required to be

shown on the return over the amount of the tax imposed which is shown on the

return, reduced by any rebate. Sec. 6662(d)(2)(A). A “substantial

understatement” of income tax is defined as an understatement of tax that exceeds

the greater of 10% of the tax required to be shown on the tax return or $5,000.

Sec. 6662(d)(1)(A).

      The accuracy-related penalty does not apply with respect to any portion of

the underpayment for which the taxpayer shows that there was reasonable cause

and that he acted in good faith. See sec. 6664(c)(1). The decision as to whether a

taxpayer acted with reasonable cause and in good faith is made on a case-by-case
                                        - 31 -

[*31] basis, taking into account all of the pertinent facts and circumstances. Sec.

1.6664-4(b)(1), Income Tax Regs. “Circumstances that may indicate reasonable

cause and good faith include an honest misunderstanding of fact or law that is

reasonable in light of all of the facts and circumstances, including the experience,

knowledge, and education of the taxpayer.” Id. Reliance on a tax professional

demonstrates reasonable cause when a taxpayer (1) selects a competent tax

adviser, (2) supplies the adviser with all relevant information, and (3) relies in

good faith on the adviser’s professional judgment. See Neonatology Assocs., P.A.

v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299 F.3d 221 (3d Cir. 2002).

      The Commissioner bears the burden of production with respect to the

taxpayer’s liability for the section 6662(a) penalty and must produce sufficient

evidence indicating that it is appropriate to impose the penalty.16 See sec. 7491(c);

Higbee v. Commissioner, 116 T.C. at 446-447. Once the Commissioner meets his

burden of production, the taxpayer must come forward with persuasive evidence

that the Commissioner’s determination is incorrect or that the taxpayer had

      16
          Sec. 6751(b)(1) requires written supervisory approval of the initial
determination of certain penalties. The Commissioner’s burden of production
under sec. 7491(c) includes establishing compliance with sec. 6751(b)(1). See
Graev v. Commissioner, 149 T.C. 485, 493 (2017), supplementing and overruling
in part 147 T.C. 460 (2016); see also Clay v. Commissioner, 152 T.C. 223, 249
(2019). The parties have stipulated that respondent complied with the
requirements of sec. 6751(b)(1) in this case.
                                         - 32 -

[*32] reasonable cause or substantial authority for the position. See Higbee v.

Commissioner, 116 T.C. at 446-447.

      Respondent satisfied his burden of production with respect to negligence or

disregard of rules or regulations. See secs. 6662(a) and (b)(1), 7491(c).

Petitioners underreported JTI’s gross receipts and did not maintain sufficient

records to substantiate many of the expenses underlying JTI’s deductions. The

disallowed deductions in this case are directly attributable to petitioners’ failure to

maintain adequate records.17

      Petitioners, who bear the burden of persuasion, argue that their reliance on

Mr. Drummer constitutes reasonable cause and good faith. We agree in part and

disagree in part. Petitioner husband credibly testified that he believed Mr.

Drummer was a former IRS RA on the basis of a coworker’s recommendation, and

we find it more likely than not that petitioners reasonably believed Mr. Drummer

was a competent tax adviser. See Lopez v. Commissioner, T.C. Memo. 2017-171,

at *11-*12 (citing Neonatology Assocs. P.A. v. Commissioner, 115 T.C. at 99).

      The fact that petitioners hired Mr. Drummer to prepare their returns does

not, by itself, establish that they acted with reasonable cause and good faith. See

      17
         To the extent the Rule 155 computations establish that petitioners have
substantial understatements of income tax, respondent has also met his burden of
production in this regard. See secs. 6662(a) and (b)(2), 7491(c).
                                        - 33 -

[*33] Neonatology Assocs., P.A. v. Commissioner, 115 T.C. at 99-100. They

must also establish that they supplied him with all relevant information and relied

in good faith on his professional judgment. See id. Petitioners have met this

burden only with respect to JTI’s deductions for “outside services”.

      At trial petitioner husband credibly testified that Mr. Drummer advised him

that petitioners could deduct their daughters’ tuition if they paid it through an

S corporation. Following Mr. Drummer’s advice, petitioners reported these

payments as deductible “outside services” on JTI’s 2013 and 2014 returns. While

this tax position might be “too good to be true” in other circumstances, we believe

petitioners acted in good faith here. We observed at trial that petitioners face a

significant language barrier. They have no formal training in accounting or

taxation and believed that Mr. Drummer was a tax expert and former IRS RA.

Accordingly, Mr. Drummer’s advice carried significant weight for them. We

therefore find that petitioners acted with reasonable cause and in good faith with

respect to JTI’s deductions for “outside services” for 2013 and 2014.

      Regarding all other adjustments to petitioners’ returns, petitioners have not

shown that they acted with reasonable cause and good faith. The record does not

establish that petitioners gave Mr. Drummer all relevant information with respect

to their business income and expenses. We therefore sustain those portions of the
                                         - 34 -

[*34] accuracy-related penalties that do not pertain to JTI’s “outside services”

deductions.

         The Court has considered all of the parties’ arguments and, to the extent not

discussed above, concludes that those arguments are irrelevant, moot, or without

merit.

         To reflect the foregoing,


                                                  Decision will be entered

                                         under Rule 155.
