                          T.C. Memo. 1999-408



                        UNITED STATES TAX COURT



         ALFRED L. AND RENEE E. FIELDS, ET AL.,1 Petitioners v.
              COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos.     22011-97, 22012-97,    Filed December 15, 1999.
                     22013-97, 22014-97.


     Douglas E. Kahle, for petitioners.

     John C. McDougal and Dustin M. Starbuck, for respondent.



                MEMORANDUM FINDINGS OF FACT AND OPINION


     JACOBS, Judge:      These cases were consolidated for trial,

briefing, and opinion.       Respondent determined deficiencies in



     1
          Cases of the following petitioners are consolidated
herewith: Frank H. and Irma E. Bullock, docket No. 22012-97;
Leroy and Mattrude P. Sharpe, docket No. 22013-97; and Esker L.
Peacock, docket No. 22014-97.
                                    - 2 -


petitioners’ Federal income taxes, additions to tax, and penalties,

as follows:

Alfred L. and Renee E. Fields, Docket No. 22011-97:

                        Additions to tax        Accuracy-Related Penalty
Year   Deficiency       Sec. 6651(a)(1)               Sec. 6662(a)

1993    $10,913            $2,188                         $2,183
1994     18,871             4,718                          3,774

Frank H. and Irma E. Bullock, Docket No. 22012-97:

                        Additions to tax        Accuracy-Related Penalty
Year   Deficiency       Sec. 6651(a)(1)              Sec. 6662(a)

1993     $12,510              ---                        $2,502
1994      21,422             $967                         4,284


Leroy and Mattrude P. Sharpe, Docket No. 22013-97:

                              Accuracy-Related Penalty
Year       Deficiency               Sec. 6662(a)

1993           $8,337                  $1,667
1994           18,467                   3,693


Esker L. Peacock, Docket No. 22014-97:

                              Accuracy-Related Penalty
Year       Deficiency              Sec. 6662(a)

1993          $11,103                 $2,221
1994           19,403                  3,881

       After concessions, the issues for decision are: (1) Whether

petitioners    had   unreported     income      during   the   years   under

consideration as determined by respondent; (2) whether petitioners

in docket No. 22012-97 (the Bullocks) are entitled to losses

claimed in connection with Frank Bullock’s van pool activity; (3)
                               - 3 -


whether petitioners in docket Nos. 22011-97 and 22012-97 (the

Fieldses and the Bullocks) are liable for additions to tax pursuant

to section 6651(a)(1) for failure to timely file a return; and (4)

whether petitioners are liable for the accuracy-related penalty

pursuant to section 6662(a).

     All section references are to the Internal Revenue Code as in

effect for the years under consideration.   All Rule references are

to the Tax Court Rules of Practice and Procedure.

                         FINDINGS OF FACT

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

stipulation of facts and the attached exhibits are incorporated

herein by this reference.

     Petitioners Alfred L. and Renee E. Fields, husband and wife,

(the Fieldses) resided in Chesapeake, Virginia, at the time they

filed their petition contesting respondent's determinations.    The

Fieldses filed their 1993 and 1994 Federal income tax returns late.

     Petitioners Frank H. and Irma E. Bullock, husband and wife,

(the Bullocks), Leroy and Mattrude P. Sharpe, husband and wife,

(the Sharpes), and Esker L. Peacock (Mr. Peacock) all resided in

Portsmouth, Virginia, at the time they filed their respective

petitions contesting respondent's determinations.     The Bullocks

timely filed their 1993 Federal income tax return but filed their

1994 return late.   Both the Sharpes and Mr. Peacock timely filed

their 1993 and 1994 Federal income tax returns.
                                       - 4 -


The 4 Leaf Corporation

        The 4 Leaf Corporation (4 Leaf Corp.), a Virginia corporation,

was incorporated on April 21, 1992.             At all relevant times, 4 Leaf

Corp. had its principal place of business in Hampton, Virginia

(City of Hampton). During the years under consideration, Alfred

Fields (Mr. Fields), Mr. Bullock, Leroy Sharpe (Mr. Sharpe), and

Mr. Peacock each owned 25 percent of 4 Leaf Corp.'s outstanding

stock.

      On October 6, 1992, 4 Leaf Corp. leased a building located in

Hampton, Virginia, which became known as the Buckroe Plaza Bingo

Hall (Buckroe). It was originally intended that the building would

be used for concerts, dances, bingo, and conferences. However,

after the City of Hampton prohibited 4 Leaf Corp. from sponsoring

a dance at the building, Buckroe was used exclusively as a bingo

hall.

Bingo Operations at Buckroe

        Under Virginia law (1) only “qualified organizations” (i.e.,

charitable and fraternal organizations) may operate bingo games,

and   (2)   the   workers   at   the    games    must   be   members   of   those

charitable and fraternal organizations, working as volunteers. See

Va. Code Ann. secs. 18.2-3450.1-4, 18.2-340.9 (Michie 1993).

        During 1993, the bingo games at Buckroe were sponsored by two

charitable organizations: The Association for the Restoration of

Historic Cemeteries (the cemeteries restoration association) and
                                - 5 -


the Coalition for Community Pride and Progress (the community

coalition).    In 1994, a fraternal organization known as the Mighty

O’Jays (the O’Jays) was added as a sponsor. (Messrs. Fields,

Bullock, Sharpe, and Peacock were members of the O’Jays.)        All

three organizations (hereinafter collectively referred to as the

sponsoring organizations) purportedly were qualified organizations

for purposes of conducting bingo games under Virginia law.

     During 1993 and 1994, bingo games took place at Buckroe twice

a week.     Each of the sponsoring organizations provided persons to

work the bingo games. At different times, Messrs. Fields, Bullock,

Sharpe, or Peacock helped train new floor workers, maintained the

financial records, and were present at Buckroe during the bingo

sessions.

     As an accommodation, 4 Leaf Corp. purchased bingo supplies

(i.e., game cards, chips, markers, etc.) from Bingo Products, Inc.,

and sold the supplies to the sponsoring organizations at cost.

These supplies were subsequently sold, at a profit, to the bingo

players.

     At the end of an evening of bingo, "bingo accountability

sheets" were used to record the aggregate cost of supplies and the

amount paid out as prizes.2     The bingo accountability sheets did


     2
          There were no bingo accountability sheets for
approximately 10 percent of the bingo games held in 1993 and
1994. Further, some of the information on the bingo
                                                   (continued...)
                              - 6 -


not separately account for each session of bingo but rather treated

all three nightly sessions as a single undertaking.   All expenses

for the supplies were borne evenly by the sponsoring organizations.



     In 1994, the City of Hampton audited the bingo operations

conducted at Buckroe.   The City of Hampton determined that the

sponsoring organizations were not in compliance with State and

local laws governing the operation of bingo games; changes were

thereafter made in order to have the sponsoring organizations

comply with the applicable laws.

Internal Revenue Service Examination

     In early 1995, the Internal Revenue Service (IRS) began an

examination of both 4 Leaf Corp. and petitioners as part of a

“bingo project” jointly conducted by the IRS’ Examination and

Exempt Organizations Divisions.    The agent coordinating the bingo

project, Revenue Agent Gross, requested Mr. Bullock to produce the

records of 4 Leaf Corp.; Mr. Bullock told Revenue Agent Gross to

see Mr. Schefletle, 4 Leaf Corp.’s accountant. Because the records

of 4 Leaf Corp. were incomplete, Mr. Schefletle had to reconstruct

the corporation’s general ledger and income statements.    The only

revenues reported on the reconstructed corporate books and on 4




     2
      (...continued)
accountability sheets was incomplete and/or absent.
                                 - 7 -


Leaf Corp.’s tax returns for 1993 and 1994 were rents from Buckroe

and income from the operation of a snack bar at the hall.

     As part of the IRS examination, Revenue Agent Gross and other

agents interviewed between 15 and 20 workers at the bingo games

held at Buckroe. The revenue agents attempted to obtain records of

the bingo operations from the sponsoring organizations but were

unsuccessful.    Consequently, the IRS reconstructed the income from

the bingo games held at Buckroe by the percentage markup method,

based on bingo supplies purchased for the games.         The determined

profit was based, in part, on information obtained from the Bingo

Bulletin (a commercial publication for the bingo industry) which

published the sales prices for the various products sold during the

games and prize payouts.3       On the basis of the aforementioned

methodology,     respondent   determined   the   gross   income,   total

expenses, and net income from bingo operations at Buckroe for 1993

and 1994 as follows:

                                 1993                1994

Gross receipts                 $979,080          $1,720,614
Expenses                        859,123           1,502,540

     Net income                 119,957             218,074

     After allowing a reduction in net income for “illegal payments

to workers” and after allowing payments to each of the sponsoring


     3
          The bingo games at Buckroe were advertised in the Bingo
Bulletin, as well as the prices charged for packages of bingo
cards and the prize payouts.
                               - 8 -


organizations, respondent determined that there was cash ($54,416

for 1993 and $106,038 for 1994) available for distribution to

Messrs. Fields, Bullock, Sharpe, and Peacock, computed as follows:

                                       1993             1994

Net income                        $119,957            $218,074
 Less: payments to workers         (62,841)           (101,010)
 Less: payments to charities        (2,700)            (11,025)

  Net income available for
    distribution                      54,416           106,039

The Bullocks’ Van Pool Activity

     During 1993 and 1994, and for approximately 8 years prior

thereto, Mr. Bullock operated a van pool in which he provided

transportation to and from work to a number of individuals in

exchange for a predetermined fee.       Mr. Bullock operated the van

pool between his residence in Portsmouth, Virginia, and both the

Naval Air Station in Norfolk, Virginia, and the Newport News

Shipyard in Newport News, Virginia.

     Mr. Bullock owned the van used in the van pool activity.     He

drove the van from Portsmouth to Norfolk, where he was employed as

a supply clerk.   Another person drove the van from Norfolk to the

Newport News Shipyard. This other person was permitted to ride for

free.

     Other than canceled checks for expenses paid out of Mr.

Bullock's personal checking account, Mr. Bullock did not maintain

contemporaneous records of the expenses incurred in operating the
                                   - 9 -


van   pool.   (These   canceled    checks     were   not   introduced     into

evidence.)    Mr. Bullock failed to maintain a mileage log or a

separate bank account for his van pool activities.

      Mr. Bullock prepared a summary of his income and expenses at

the end of each year for use by his tax return preparer.              On their

1993 and 1994 Federal income tax returns, the Bullocks reported

income, expenses, and net losses from the van pool activity as

follows:

                            1993                            1994

Gross receipts                       $6,020                          $2,007
Expenses:
     Depreciation          $980                            $1,517
     Insurance            3,000                             3,000
     Supplies                75                              ---
     Repairs                ---                             1,170
     Taxes                  403                             1,213
     Other                6,285                             3,900
   Total expenses                    10,743                          10,800
   Loss                              (4,723)                         (8,793)

IRS’ Position and Determinations

      Respondent determined that Messrs. Fields, Bullock, Sharpe,

and Peacock each received unreported cash distributions from 4 Leaf

Corp. from the bingo operations conducted at Buckroe.               The amounts

now ascribed to each of them from these activities by respondent

are $13,604 for 1993 and $26,509.75 for 1994.         (The deficiencies in

tax as set forth in the notices of deficiencies were based on

greater amounts of purported unreported income.)
                                     - 10 -


     With respect to the Bullocks, respondent disallowed the van

pool losses (1) for lack of substantiation of the expenses, and (2)

on the basis of respondent’s determination that the Bullocks lacked

a profit objective for the activity.             The Bullocks did not appear

at trial, and there was no evidence offered to substantiate any of

the expenses deducted on their returns with respect to the van pool

activity.

                                     OPINION

Issue 1:    Reconstruction of Petitioners' Income

     The    underlying         dispute    presented     herein       relates   to

respondent's reconstruction of income purportedly generated by the

bingo operations conducted at Buckroe, and respondent’s allocation

of that reconstructed income to Messrs. Fields, Bullock, Sharpe,

and Peacock. Petitioners adamantly maintain that all proceeds, net

of rent and administrative expenses incurred in connection with the

operation   of   the    bingo    games,   went    to   the   three    sponsoring

organizations, and not to them or to 4 Leaf Corp.

     The methodology used by respondent in reconstructing the

purported bingo income–-the percentage markup method–-is a time-

honored, judicially accepted method of reconstructing income.                  See

Bernstein v. Commissioner, 267 F.2d 879 (5th Cir. 1959), affg. T.C.

Memo.   1956-260;      Stone    v.   Commissioner,     22    T.C.   893   (1954);

Cebollero v. Commissioner, T.C. Memo. 1990-618, affd. 967 F.2d 986

(4th Cir. 1992).       Although in theory respondent’s methodology was
                                        - 11 -


reasonable, we believe that here it did not produce a correct

result.

       In Diaz v. Commissioner, 58 T.C. 560, 562 (1972), we noted

that    the   process    of     distilling   truth     from    the    testimony    of

witnesses is the daily grist of judicial life.                        At trial, we

observed Messrs. Fields, Sharpe, and Peacock as they testified, and

we had the opportunity to evaluate their credibility.                     We found

their testimony to be credible.

       On the basis of their testimony, and that of others, we are

convinced that all proceeds of the bingo games, net of expenses,

went     to   the   sponsoring        organizations,     not    to    petitioners.

Respondent’s evidence to the contrary was not convincing.                   Indeed,

under    respondent’s     “alternative       method”    which    used    the   bingo

accountability sheets, one could extrapolate that all net income

from    the   bingo     games    went   to   the   sponsoring        organizations.

Accordingly, we do not sustain respondent’s determination that

petitioners had unreported income for 1993 and 1994.

Issue 2:      Losses From Van Pool Activity

        We now address the losses claimed by the Bullocks arising from

Mr. Bullock’s van pool activity.

       The parties have stipulated (1) the amounts of income and

expenses      reported   on     the   returns    for   the    activity,    (2)    Mr.

Bullock’s driving of the van coincided with his own commute, and

(3) no contemporaneous records were maintained.                      The record is
                                   - 12 -


devoid of any other facts about the operation of the van pool, such

as the number of passengers and the amounts, if any, charged to

each.

     In    the   notice   of   deficiency,    respondent   disallowed   the

expenses of the van pool operation to the extent they exceeded

reported income on the grounds that the amount and deductibility of

such expenses had not been substantiated.         In addition, respondent

disallowed the van pool losses on the grounds that Mr. Bullock did

not enter into the van pool arrangement with an “actual and honest

objective of making a profit.”       Beck v. Commissioner, 85 T.C. 557,

569 (1985); see sec. 1.183-2(a), Income Tax Regs.

        Petitioners bear the burden of substantiating the amount and

deductibility of expenses claimed on their returns.                See Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).          There is no

evidence in the stipulation of facts or in the trial record to show

the amount or business purpose of any of the van pool expenses

claimed    on    the   Bullocks’   returns.   Consequently,   we    sustain

respondent's disallowance of the claimed         Schedule C deductions by

the Bullocks for the van pool activity.

Issue 3:    Additions to Tax and Penalties

     The remaining issues relate to additions to tax and penalties;

i.e., whether (a) the Fieldses and the Bullocks are liable for

additions to tax for failure to timely file a return under section

6651(a)(1), and (b) whether all petitioners are liable for the
                                           - 13 -


section 6662(a) accuracy-related penalties for the years in issue

for negligence or disregard of rules or regulations or substantial

understatement of tax.

     Section 6651(a)(1) imposes an addition to tax of 5 percent of

the amount of tax due per month for each month that a tax return is

not timely filed. An exception is made for taxpayers demonstrating

reasonable cause.          Section 6662(a) imposes a penalty equal to 20

percent     of    the     amount      of   the    underpayment    attributable     to

negligence or disregard of rules or regulations or substantial

understatement of tax.

     On brief, respondent concedes that if we find that there is no

unreported       income    from      bingo    operations,    then    there   are   no

additions to tax for late filing or penalties for negligence due

from any of the petitioners except the Bullocks.                    Because we have

concluded    that       there   is    no   unreported    income     from   the   bingo

operations, the Fieldses are not liable for the addition to tax

under section 6651(a)(1), and the Fieldses, Sharpes, and Mr.

Peacock are not liable for the accuracy-related penalties under

section 6662(a) for the years in issue.

     The Bullocks have failed to present any credible evidence to

rebut respondent's determination of the accuracy-related penalty or

the addition to tax attributable to the disallowed Schedule C

deductions       from     the   van    pool      activity.    See     Tweeddale    v.

Commissioner, 92 T.C. 501, 505 (1989) (holding that the taxpayer
                              - 14 -


bears the burden of establishing that he is not liable for the

accuracy-related penalty); Espinoza v. Commissioner, T.C. Memo.

1999-269 (holding that the taxpayer bears the burden of proof on

the issue of a section 6651 addition to tax.)      Accordingly, we

sustain respondent's determination that the Bullocks are liable for

the section 6651(a)(1) addition to tax to the extent of the

underpayment relating to the disallowed Schedule C deductions for

1993 and 1994. We likewise sustain respondent’s determination that

the Bullocks are liable for the accuracy-related penalties under

section 6662(a) for both years.

     In reaching our conclusions herein, we have considered all

arguments presented and, to the extent not discussed above, find

them to be irrelevant or without merit.

     To reflect the foregoing and respondent's concessions,



                                                 Decisions will be

                                            entered under Rule 155.
