                        T.C. Memo. 2017-103



                  UNITED STATES TAX COURT



   JOSEPH WAGES AND JENNIFER G. WAGES, Petitioners v.
    COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 27579-12.                        Filed June 7, 2017.



   H operated bail bonding and towing businesses throughout tax
years 2008, 2009, and 2010. In connection with his bail bonding
business, H made payments into a surety’s indemnity fund,
deductions for which R denied for tax years 2008, 2009, and 2010.
R also changed Ps’ accounting method, requiring the inclusion in
income of the indemnity fund’s balance as of January 1, 2008.

   With respect to H’s business activities, Ps also claimed deductions
for tax years 2008, 2009, and 2010, which R denied, for car and truck
expenditures, office expenditures, insurance, subcontractors, cost of
goods sold, depreciation, and supplies. R’s further adjustments to Ps’
tax items for the 2008, 2009, and 2010 tax years are not in dispute.

   Held: R’s adjustments are sustained because Ps have failed to
prove by a preponderance of the evidence that the determinations in
the notice of deficiency are incorrect.
                                        -2-

[*2] James G. McGee, Jr., and William H. Webb, for petitioners.

      Edwin B. Cleverdon, Brooke W. Patterson, John F. Driscoll, and Horace

Crump, for respondent.



                           MEMORANDUM OPINION


      LARO, Judge: This case arises out of respondent’s adjustments to

petitioners’ returns for the 2008, 2009, and 2010 tax years. The case was

submitted fully stipulated for decision without trial. See Rule 122.1

      Respondent determined deficiencies in petitioners’ Federal income tax, as

well as additions to tax and penalties under sections 6651(a)(1) and 6662(a),

respectively, for the taxable years and in the amounts as follows:

                                     Additions to tax       Penalties
      Year          Deficiency       sec. 6651(a)(1)      sec. 6662(a)

      2008          $79,913            $11,986.95          $15,982.60
      2009           37,316              9,329.00            7,463.20
      2010           66,567             16,641.75           13,313.40

Petitioners have conceded all adjustments, along with the general applicability of

the additions to tax under section 6651(a)(1) and penalties under section 6662(a),

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

[*3] except that they dispute respondent’s change to their method of accounting

and his disallowance of certain claimed deductions.

      After petitioners’ concessions, we decide these remaining issues:

      (1) whether petitioners may deduct for tax years 2008, 2009, and 2010

payments made to an indemnity fund maintained with respect to Joseph Wages’

bail bonding activity. We hold that they may not;

      (2) whether respondent properly changed petitioners’ accounting method

with respect to Mr. Wages’ indemnity fund related to his bail bonding activity,

resulting in additional income for tax year 2008. We hold that he did;

      (3) whether petitioners have substantiated their claimed deductions for car

and truck expenditures, office expenditures, insurance, subcontractors, cost of

goods sold, depreciation, and supplies for tax years 2008, 2009, and 2010 with

respect to Mr. Wages’ bail bonding activity. We hold that they have not.

                                    Background

I.    Overview

      The parties submitted this case fully stipulated under Rule 122. The Court

subsequently ordered the parties to file simultaneous opening and answering

briefs. Respondent filed two briefs; petitioners opted to file only an opening brief.

The stipulations of facts and settled issues are incorporated herein. Petitioners are
                                         -4-

[*4] residents of Mississippi. This case is appealable to the Court of Appeals for

the Fifth Circuit absent stipulation of the parties to the contrary.

II.   Mr. Wages’ Business Activities

      While the Court left the record in this case open for a month and a half after

the parties’ submission of their first stipulation of facts, no supplemental

stipulation of facts followed during that time (one was filed later solely to

introduce evidence of the petition’s timely mailing); nor has either party moved to

enter any substantive evidence beyond the agreed-upon statements in the first

stipulation of facts and the stipulation of settled issues. Accordingly, we must

render our decision on the basis of the record before us, limited as it may be.

      The record shows that during the years at issue Mr. Wages operated bail

bonding and towing businesses, to which respondent’s adjustments relate. As part

of his bail bonding business, Mr. Wages made certain payments to an indemnity

fund. Furthermore, he claims to have incurred various expenses (which petitioners

sought to deduct on their Federal income tax returns, and which, to the extent they

remain disputed, are enumerated below) in the course of his bail bonding and

towing businesses.
                                        -5-

[*5] III.    Petitioners’ Tax Returns

       Petitioners admit that they neglected to file timely their Federal income tax

returns for the years in issue. Their 2008 return was due on October 15, 2009, but

was filed on January 4, 2010. Their 2009 return was due on April 15, 2010, but

was filed on May 24, 2011. And their 2010 return was due on April 15, 2011, but

was filed on October 19, 2011.

       Petitioners’ tax returns have not been entered into the record, nor have the

parties stipulated the content thereof. Nonetheless, from the pleadings we gather

that petitioners filed Schedules C, Profit or Loss From Business, on which they

claimed deductions for the various expenses at issue here. Mr. Wages aggregated

the income and expenses for his two businesses on a single Schedule C for each of

the tax years 2008, 2009, and 2010. Petitioners attached a separate Schedule C for

Jennifer Wages to their 2008 Federal income tax return, which they admit now to

having been done in error.

IV.    Respondent’s Adjustments and Petitioners’ Concessions

       Respondent on August 8, 2012, issued a notice of deficiency to petitioners

with respect to their income tax liabilities for tax years 2008, 2009, and 2010. As

we noted above, petitioners have conceded some of respondent’s adjustments; we

concern ourselves with only those that remain disputed.
                                        -6-

[*6] Respondent determined that payments into an indemnity fund in connection

with Mr. Wages’ bail bonding business were not currently deductible. Thus

respondent adjusted “other income” upward on Mr. Wages’s 2008 Schedule C by

changing petitioners’ accounting method and including in income the $69,963

balance of the indemnity fund as of January 1, 2008, thereby offsetting all

previous deductions petitioners had claimed with respect to that indemnity fund.

Furthermore, respondent adjusted upward: (1) “insurance” on Mr. Wages’ 2008

Schedule C by $46,398; (2) “other expenses” on Mr. Wages’ 2009 Schedule C by

$33,445; and (3) “other expenses” on Mr. Wages’ 2010 Schedule C by $27,912.

The parties agree that the amounts at issue are accurate but dispute the legal

question of whether petitioners are entitled to claim current deductions for

amounts paid to the indemnity fund.

      In addition to his denial of a deduction for the indemnity fund payments,

respondent disallowed several of petitioners’ claimed Schedule C expense

deductions on the grounds that petitioners failed to establish that the amounts were

ordinary and necessary business expenses, were expended for the purposes

designated, and were substantiated as required by section 274(d). Respondent also

disallowed petitioners’ claimed depreciation deductions on the grounds that

petitioners failed to establish that any property was depreciable or used in a trade
                                         -7-

[*7] or business, or that they had a cost or other basis in it. Thus, respondent made

the following disputed upward adjustments to the Schedule C items for the tax

years specified:

             Item                 2008                2009                2010

      Car/truck expenses         $24,589            $17,669             $8,794
      Office expenses              3,500               -0-                -0-
      Insurance                    -0-                4,499              4,881
      Contract labor             121,500               -0-             148,645
      COGS-- purchases              -0-              63,687               -0-
      Depreciation/179             -0-                7,572             18,171
      Supplies                     -0-                 -0-              19,924

Petitioners claim that, although they do not have all the underlying records with

respect to these expenses, the stipulated documentation in this case is sufficient to

support deductions for them.

      The parties further agree that the adjustments in the notice of deficiency

relating to self-employment tax, the deduction for self-employment tax,

exemptions, and the net operating loss carryforward are automatic and subject to

change based on the substantive adjustments in this case. The parties concur that

the penalties under section 6662(a) and the additions to tax under section

6651(a)(1) apply as indicated in the notice of deficiency.
                                          -8-

[*8] V.      Timeliness of Petition

      The last day for petitioners to file a petition with the Court was November

6, 2012. The petition, signed by petitioners’ counsel and dated November 6, 2012,

was received and filed by the Court in the morning of November 13, 2012. The

envelope in which the petition arrived bore “stamps.com” postage and a certified

mail sticker with a tracking number. There was no postmark, however, and since

the Court received the petition after the date prescribed for filing it, the Court sua

sponte raised the question of its jurisdiction under section 6213(a) to decide the

case. Unless petitioners could show that they timely mailed their petition, they

could not avail themselves of the section 7502(a) mailbox rule, which allows a

timely mailed document to be treated as timely filed.

      Notwithstanding initial difficulties in finding evidence of their timely

mailing of the petition, petitioners eventually found a certified mail receipt and the

corresponding return receipt, each bearing a tracking number corresponding to that

on the envelope in which the petition was mailed. The certified mail receipt bore a

U.S. Postal Service postmark dated November 6, 2012, which under section

301.7502-1(c)(2), Proced. & Admin. Regs., is treated as the postmark date of the

mailed document. The parties jointly stipulated the validity of the certified mail

receipt and further stipulated that it shows that petitioners timely filed their
                                         -9-

[*9] petition. Thus, we conclude that the petition (1) was contained in a properly

addressed envelope, (2) was deposited within the prescribed time in the mail in the

United States with sufficient postage prepaid, and (3) bore a constructive postmark

as evidenced by the U.S. Postal Service postmark on the certified mail receipt.

See sec. 301.7502-1(c)(1) and (2), Proced. & Admin. Regs. Accordingly,

petitioners have established the mailbox rule’s applicability to their case, see sec.

7502(a), and borne their burden of proving that we have jurisdiction thereover, see

David Dung Le, M.D., Inc. v. Commissioner, 114 T.C. 268, 270 (2000), aff’d, 22

F. App’x 837 (9th Cir. 2001).

                                     Discussion

I.    Overview

      Generally, the Commissioner’s determination of a taxpayer’s liability for an

income tax deficiency is presumed to be correct, and the taxpayer bears the burden

of proving the determination improper by a preponderance of the evidence. See

Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Deductions are a

matter of legislative grace, and the taxpayer must prove his entitlement to any

deductions claimed. INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992).

Taxpayers are obligated to maintain sufficient records to substantiate expenses

underlying their claimed deductions. Sec. 6001.
                                         - 10 -

[*10] II.    Petitioners’ Proposed Findings of Fact

      Petitioners have asserted a number of facts in their brief. Petitioners’

proposed findings of fact explain the indemnity fund arrangement between Mr.

Wages’ bail bonding business and the surety for which it was acting as an agent.

The proposed findings of fact further allege that an independent contractor

appointed by petitioners as their agent with respect to the bail bonding business,

who took over the daily operations of the business after Mr. Wages suffered a

stroke, stole petitioners’ records and established a competing bail bonding

business. Petitioners state that they have initiated a lawsuit against the former

contractor in the circuit court for Rankin County, Mississippi.

      Respondent objects to most of petitioners’ proposed findings of fact on two

grounds: first, that petitioners failed to comply with Rule 151(e)(3), which

requires that each finding of fact cite the “pages of the transcript or the exhibits or

other sources relied upon to support the statement”, and second, that the asserted

facts are allegations not supported by the record before the Court.

      We agree with respondent. The record in this case, notwithstanding the

Court’s holding it open for a month and a half after the parties’ submission of their

first stipulation of facts, is barren. Whatever facts have been established we recite

in the “Background” section of this opinion. Petitioners’ remaining proposed
                                        - 11 -

[*11] findings of fact find no support in the record: There are no stipulations,

exhibits, or any other sources corroborating them, outside unsworn statements

made in petitioners’ petition, pretrial memorandum, and brief. Thus, we must

accept the limited record in this case as it stands and decide the disputed issues

accordingly.

III.   Deductibility of Payments to Indemnity Fund

       The parties agree that Mr. Wages made payments to an indemnity fund in

the course of his bail bonding business. Respondent disallowed the current

deduction thereof in the amounts of $46,398 for 2008, $33,445 for 2009, and

$27,912 for 2010.

       A.      The Parties’ Arguments

       In support of his disallowance of petitioners’ deductions, respondent cites

Sebring v. Commissioner, 93 T.C. 220, 224 (1989), in which this Court held that

payments by a bail bondsman into an indemnity fund maintained by the surety for

which he is an agent are deposits to secure payment of future liabilities and are not

deductible until the insurance company draws from the account to satisfy a

specific liability. See also, e.g., Zweifel v. Commissioner, T.C. Memo. 2012-93.

Since the record in this case does not indicate that amounts paid into the indemnity

fund have qualities or characteristics different from those in Sebring,
                                        - 12 -

[*12] respondent argues, petitioners are unable to satisfy their burden of proof on

this issue.

       Petitioners rest their argument on a different theory. They contend that the

indemnity fund is controlled by a third-party surety and Mr. Wages’ bail bonding

business has no right to funds within the indemnity account, except insofar as a

liability for which the business must indemnify the surety is discharged.

Petitioners maintain that because the business has no control over or access to the

funds, nor an expectation of their reacquisition, the amounts remitted to the fund

should be deductible when paid. Petitioners further argue that should Mr. Wages’

bail bonding business reacquire any sums from the indemnity fund in the future,

those amounts should be recaptured in that year’s gross receipts under the tax

benefit rule codified in section 111.

       Respondent disagrees with petitioners’ theory. First, he points out that

petitioners’ argument rests on allegations that are not part of the evidentiary record

in the case and thus petitioners have not sustained their burden of proof. Second,

respondent argues that the tax benefit rule requires the inclusion in income only of

a recovered amount for which the taxpayer had received a tax benefit in a prior

year, see Hillsboro Nat’l Bank v. Commissioner, 460 U.S. 370 (1983), and does

not support a claim for any type of deduction. Section 111, respondent asserts,
                                        - 13 -

[*13] ensures only that the liability resulting from the tax benefit rule does not

exceed the benefit received in a prior year; it authorizes no deduction.

      B.     Petitioners’ Burden of Proof

      We agree with respondent that petitioners have failed to satisfy their burden

of proof. As we observed above, the burden is on the taxpayer to prove by a

preponderance of the evidence that the notice of deficiency is incorrect. See Rule

142(a); Welch v. Helvering, 290 U.S. at 115. Petitioners have adduced no

evidence in support of their theory that respondent improperly denied their

deductions for payments into an indemnity fund in 2008, 2009, and 2010. They

have introduced nothing into the record that would allow the Court to scrutinize

the arrangement between Mr. Wages’ bail bonding business and the third-party

surety or the nature of the indemnity fund to which the payments were remitted.

Since petitioners have failed to satisfy their burden of proof, we need not reach the

substantive legal question of the timing of deductions for payments by a bail

bonding agent to an indemnity fund. Because we are unable to conclude that

respondent’s denial of petitioners’ deductions for the indemnity fund payments

was improper, we sustain his determination.
                                        - 14 -

[*14] IV.    Change of Petitioners’ Accounting Method

      In the notice of deficiency, respondent changed petitioners’ accounting

method to include in income the $69,963 balance of the indemnity fund as of

January 1, 2008. This change offset previous deductions petitioners had claimed

with respect to payments remitted to the indemnity fund.

      A.     The Parties’ Arguments

      Respondent points out that he has the authority under sections 446(b) and

481 to change a taxpayer’s method of accounting. He also cites Rankin v.

Commissioner, T.C. Memo. 1996-350, aff’d, 138 F.3d 1286 (9th Cir. 1998), for

the proposition that the change in treatment of amounts accumulated in a bail bond

indemnity fund before the years in issue in that case was a proper change in

method of accounting, because the change affected only the timing of inclusion

and not its ultimate fact. See also Firetag v. Commissioner, T.C. Memo. 1999-

355, aff’d without published opinion, 232 F.3d 887 (4th Cir. 2000). Since the

record in this case includes no indication that the indemnity fund had any

characteristics different from those of the fund in Rankin, respondent contends,

petitioners are unable to satisfy their burden of proof on this issue.

      Petitioners in their petition asserted that because respondent’s audit and

resultant notice of deficiency pertained only to tax years 2008, 2009, and 2010,
                                       - 15 -

[*15] and the limitations periods for previous tax years had expired, the change in

accounting method violated petitioners’ procedural due process rights and was an

attempt by respondent to circumvent the statute of limitations. However,

petitioners failed to advance any argument on the accounting method change in

their pretrial memorandum or their brief.

      B.     Petitioners’ Burden of Proof

      From petitioners’ failure in their pretrial memorandum and brief to argue the

accounting method change separately from respondent’s disallowance of their

claimed deductions for the indemnity fund remittances, we infer that they have

abandoned their due process and statute of limitations theories. Since petitioners

have abandoned their separate arguments on the change of accounting method, and

since they have adduced no evidence with respect to it, we find that they have

failed to carry their burden of proof with respect to this adjustment. See Rule

142(a); Welch v. Helvering, 290 U.S. at 115. Accordingly, we sustain

respondent’s change of petitioners’ accounting method.

V.    Deductions for Claimed Expenses

      Respondent disallowed the deduction for tax years 2008, 2009, and 2010 of

certain expenses for car and truck, office, insurance, subcontractors, cost of goods
                                         - 16 -

[*16] sold, depreciation, and supplies. The denied deductions totaled $149,589

for tax year 2008, $93,427 for tax year 2009, and $200,415 for tax year 2010.

      A.     The Parties’ Arguments

      Respondent argues that while section 162(a) generally allows for the

deduction of ordinary and necessary trade or business expenses, and while section

167(a)(1) generally provides a depreciation deduction for the exhaustion, wear,

and tear of property used in a trade or business, petitioners have failed to

substantiate their expenses in this case. Respondent points out that taxpayers are

required to maintain sufficient records to establish their tax liability, see sec. 6001;

Hradesky v. Commissioner, 65 T.C. 87, 89-90 (1975), aff’d, 540 F.2d 821 (5th

Cir. 1976), and that self-serving declarations generally are not a sufficient

substitute for records, Weiss v. Commissioner, T.C. Memo. 1999-17, 1999 WL

34813, at *9. Respondent also draws the Court’s attention to section 274(d),

which imposes strict substantiation rules for certain trade or business expenses,

including those for the use of most motor vehicles. In sum, respondent contends

that the record in this case contains no documentation or substantiation of

petitioners’ claimed expenses or depreciation deductions and that petitioners

therefore are unable to satisfy their burden of proof on this issue.
                                         - 17 -

[*17] For their part, petitioners assert that through no fault of theirs a third party

took their records and that this entitles them to reconstruct their records to

substantiate the deductions claimed. Petitioners point to section 1.274-5T(c)(5),

Temporary Income Tax Regs., 50 Fed. Reg. 46022 (Nov. 6, 1985), which allows

taxpayers to substantiate deductions by reasonable reconstruction “[w]here the

taxpayer establishes that the failure to produce adequate records is due to the loss

of such records through circumstances beyond the taxpayer’s control, such as

destruction by fire, flood, earthquake, or other casualty”. Petitioners further argue

that under Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930),

taxpayers, when unable to produce records of actual expenditures, may rely on

reasonable estimates, provided that there is some factual basis therefor.

Petitioners assert that during examination they provided reconstructed records to

respondent that should amply satisfy their burden to substantiate their claimed

deductions.

      Respondent in his answering brief points out that the Cohan rule allows the

Court to approximate the amount of an allowable deduction where a taxpayer has

established that he paid or incurred a deductible business expense but does not

establish its amount; however, the rule applies only where there is sufficient

evidence in the record to provide a basis for the estimate. See Vanicek v.
                                        - 18 -

[*18] Commissioner, 85 T.C. 731, 742-743 (1985). And while section 1.274-

5T(c)(5), Temporary Income Tax Regs., supra, allows taxpayers to substantiate

deductions by reasonable reconstruction, respondent urges that the Cohan rule

does not apply to the items required to be substantiated under section 274(d).

Respondent argues that the record contains no evidence supporting the claimed

deductions. It is irrelevant what documentation petitioners provided to respondent

during the underlying examination, respondent contends, because under

Greenberg’s Express, Inc. v. Commissioner, 62 T.C. 324, 328 (1974), the Court

considers issues de novo on the basis of the record immediately before it.

      B.     Substantiation of Petitioners’ Deductions

      We agree with respondent and find that petitioners have not substantiated

their reported expenses. As we took pains to note above, the record in this case is

sparse. Petitioners have presented nothing to the Court to establish either the fact

of their payment of the expenses in question or the amounts thereof.

      Petitioners urge us to apply the Cohan rule to find in their favor. It is true

that under Cohan v. Commissioner, 39 F.2d at 543-544, if a taxpayer claims a

deduction or tax credit but cannot fully substantiate the underlying expense, the

Court may approximate the allowable amount, bearing heavily against the

taxpayer whose inexactitude in substantiating the amount of the expense is of his
                                        - 19 -

[*19] own making. However, the Court must have some basis upon which to

make its estimate, else the allowance would amount to “unguided largesse”.

Green Gas Del. Statutory Tr. v. Commissioner, 147 T.C. 1, 62 (2016) (citing

Williams v. United States, 245 F.2d 559, 560 (5th Cir. 1957), and Vanicek v.

Commissioner, 85 T.C. at 742-743).

      Petitioners claim to have provided “voluminous reconstructed records” to

respondent during examination. Yet none of these records have been provided to

the Court. As respondent correctly noted, this Court does not look behind a notice

of deficiency to examine the evidence used: Proceedings herein are de novo and

based on the merits of the case and not on any previous record developed at the

administrative level. Greenberg’s Express, Inc. v. Commissioner, 62 T.C. at 327-

328. Whether petitioners provided any substantiating documents to respondent at

the examination stage is immaterial. To the extent they wished us to consider their

records, be they original or reconstructed, petitioners should have sought to enter

them into the record before this Court. They had ample time but failed to do so.

      In the absence of any evidence before us, we cannot apply Cohan to

estimate petitioners’ expenses because we have no basis upon which to make such

an approximation. All we have before us are petitioners’ unsubstantiated claims in

their petition, brief, and other filings that they incurred certain expenses. These
                                        - 20 -

[*20] unsupported statements are insufficient to justify even the roughest estimate

of petitioners’ true expenses. We therefore agree with respondent that petitioners

have failed to satisfy their burden of proof, see Rule 142(a); Welch v. Helvering,

290 U.S. at 115, and sustain his deficiency determinations.

VI.   Additions to Tax and Penalties

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

return, unless such failure was due to reasonable cause and not willful neglect.

Section 6662(a) imposes a 20% accuracy-related penalty on underpayments of tax

by reason of negligence or disregard of rules or regulations, a substantial

understatement of income tax, or a substantial valuation misstatement, among

other grounds specified in section 6662(b).

      In addition to deficiencies for tax years 2008, 2009, and 2010, respondent

determined an addition to tax under section 6651(a)(1) and a penalty under section

6662(a) for each of those years. The parties stipulated that “[t]he penalties under

I.R.C. §§ 6651(a)(1) and 6662(a), as indicated in the notice of deficiency, are

applicable”. Petitioners on brief argued that because their claimed deductions

were proper, the Court should abate the accuracy-related penalties determined

against them under section 6662(a). We infer from the parties’ stipulation that, in

the event we hold against petitioners on their claimed deductions, they concur that
                                         - 21 -

[*21] the additions to tax and the penalties were imposed correctly. We have held

respondent’s determinations of petitioners’ deficiencies for each of the tax years at

issue to be correct. Accordingly, the additions to tax and penalties under sections

6651(a)(1) and 6662(a), respectively, apply.

VII. Conclusion

         Petitioners’ claims that Mr. Wages suffered a stroke and his former

associate purloined his records, if true, paint a tragic tale. Regrettably, there is no

evidence in the record before us to substantiate either these claims or petitioners’

claimed expense deductions. Nor is there sufficient evidence to justify petitioners’

claimed deductions of indemnity fund contributions. Thus we must find that

petitioners have failed to satisfy their burden of proving by a preponderance of the

evidence that the notice of deficiency is incorrect.

         We have considered all of the parties’ arguments, and to the extent not

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

merit.

         To reflect the foregoing,


                                                        Decision will be entered for

                                                  respondent.
