Harlan v. Commissioner, Docket No. 15698-91.
| Decision Date | 13 July 1995 |
| Docket Number | Docket No. 15698-91.,Docket No. 26605-91. |
| Citation | 70 T.C.M. 48 |
| Court | U.S. Tax Court |
| Parties | Wayne L. Harlan and Terri A. Harlan v. Commissioner. |
Wayne L. Harlan and Terri L. Harlan, pro se. Carol K. Muranaka, for the respondent.
Respondent determined the following deficiencies in petitioners' Federal income taxes, additions to tax, and penalty:
Accuracy
Additions to Tax Related Penalty
------------------------ ---------------
Year Deficiency Sec. 6653(a) Sec. 6661 Sec. 6662(a)
1986 ............................. $ 36,332 1$1,817 $ 8,946 --
1987 ............................. 22,547 21,127 5,637 --
1988 ............................. 50,916 2,546 12,729 --
1989 ............................. 237,598 -- -- $47,520
1 Plus 50 percent of the interest due
2 Plus 50 percent of the interest due on the deficiency
All section references are to the Internal Revenue Code in effect for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Procedure.
After concessions by respondent, the issues for decision are: (1) Whether petitioners had unreported income for 1986; (2) whether petitioners are entitled to deductions for Schedule C expenses (with respect to 1986, 1987, and 1989) and subchapter S losses (with respect to 1987 and 1988) in excess of the amounts allowed by respondent; and (3) whether petitioners are liable for the additions to tax pursuant to sections 6653(a) and 6661 and the accuracy-related penalty pursuant to section 6662(a).
Some of the facts have been stipulated and are found accordingly. The stipulation of facts and the attached exhibits are incorporated herein by this reference. Petitioners resided in Tucson, Arizona, at the time they filed their petitions.
For ease of analysis, our findings of fact and opinion for each issue are combined, and each issue is discussed under a separate heading.
Issue 1. Income
During the years in issue, petitioners were married and filed joint Federal income tax returns. Petitioners are presently divorced.
Petitioner Wayne Harlan (Wayne) has taken approximately 2 years of college classes, including some in general accounting. Prior to 1986, he was a real estate agent. From 1986 through the present, he has been a real estate broker. From 1986 through 1989, Wayne was the sole shareholder of United American Realty, Inc. (United American), an Arizona real estate company organized as a subchapter S corporation.
Petitioner Terri Harlan (Terri) is a high school graduate. At the beginning of 1986, Terri worked as an electronics technician for Hamilton Test Systems. Later that year, she accepted a position as an electronics technician with IBM Corp. (IBM). She subsequently worked for IBM during each of the years in issue.
On their 1986 Federal income tax return, petitioners reported $22,666 of wages, $536 of interest income, and $224 of taxable refunds of State and local income taxes. In addition, they reported $11,459 of gross income on Schedule C for Wayne's business of "real estate, insurance, sub contract acct."
In the notice of deficiency, respondent determined that petitioners failed to report $67,738 of income for 1986. Respondent has since conceded that this amount contains a mathematical error, and that the notice of deficiency should have listed the amount of unreported income as $64,738. Respondent determined the unreported income by using the bank deposits method.
A summary of petitioners' bank deposits for 1986 is as follows:
Pima Savings & Loan Assn. ........... $32,086
Valley National Bank (#2001-0381) ... 35,073
Valley National Bank (#2414-7947) ... 30,840
Valley National Bank (#3213-5858 .... 3,000
Less transfers ...................... (1,375)
_______
Total ............................. 99,624
Respondent now concedes that the following amounts which respondent characterized in the notice of deficiency as taxable deposits for 1986, are in fact nontaxable deposits for that year:
An adjustment on 10/31/86 in the
Pima Savings acct. ................ $ 2,289
Transfer from H & H Associates
Checking acct. to Pima Savings .... 4,917
Transfer from Pima Savings to Terri
Harlan's acct. .................... 4,550
_______
Total ............................. 11,756
Subtracting from total bank deposits of $99,624, petitioners' reported gross income of $34,885 ($22,666 + $224 + $536 + $11,459) and respondent's concessions of $11,756, yields unexplained bank deposits totaling $52,983 for 1986. Respondent contends that petitioners' taxable income for 1986 should be increased by $52,983 to reflect these unexplained bank deposits.
Petitioners disagree with respondent's characterization. They contend that a substantial portion of these bank deposits is deposits made in connection with a fund-raising activity conducted by Wayne and a partner on behalf of the South Tucson Firefighters Association (which activity resulted in a loss to petitioners1). Petitioners further contend that the remainder of the unexplained deposits consists of transfers of funds between petitioners' various bank accounts, insurance reimbursements for medical payments made by petitioners, loans entered into by petitioners, and moneys earned by petitioners' children while attending college.
The use of the bank deposits method for computing income has been authorized by the courts for many years. Estate of Mason v. Commissioner [Dec. 33,349], 64 T.C. 651, 656 (1975), affd. [78-1 USTC ¶ 9162] 566 F.2d 2 (6th Cir. 1977). Bank deposits are prima facie evidence of income. Tokarski v. Commissioner [Dec. 43,168], 87 T.C. 74, 77 (1986); Estate of Mason v. Commissioner, supra at 656; see also Estate of Hague v. Commissioner [43-1 USTC ¶ 9258], 132 F.2d 775, 777-778 (2d Cir. 1943), affg. [Dec. 12,070] 45 B.T.A. 104 (1941). In analyzing a bank deposits case, deposits will be considered income when there is no evidence that they represent anything other than income, Price v. United States [64-2 USTC ¶ 9708], 335 F.2d 671, 677 (5th Cir. 1964); United States v. Doyle [56-1 USTC ¶ 9553], 234 F.2d 788, 793 (7th Cir. 1956).
Petitioners provided the Court with a detailed summary of the banking activity for their accounts. We accept petitioners' testimony that the disputed deposits came from nontaxable sources. Accordingly, we do not sustain respondent's determination that petitioners' gross income for 1986 should be increased to reflect the bank deposits made by petitioners.
Issue 2. Deductions
On Schedule C attached to their 1986 Federal income tax return, petitioners claimed the following deductions:
Advertising ................. $ 1,309
Bank service charges ........ 34
Car and truck expenses ...... 3,824
Depreciation ................ 766
Dues ........................ 340
Legal and prof. services .... 144
Office ...................... 1,139
Rent on business property ... 3,600
Travel and entertainment .... 615
Utilities and telephone ..... 906
P.O. box rental ............. 53
_______
Total ..................... 13,730
Respondent disputes all of the above Schedule C deductions.
It is axiomatic that taxpayers do not have an inherent right to take tax deductions. Deductions are a matter of legislative grace, requiring the taxpayers to establish their right take them. Deputy v. duPont [40-1 USTC ¶ 9161] 308 U.S. 488, 493 (1940); New Colonial Ice Co. v. Helvering [4 USTC ¶ 1292], 292 U.S. 435, 440 (1934).
Taxpayers are required to keep books and records so that they can file true and correct returns. Sec. 6001; secs. 1.446-1(a)(4), 1.6001-1(a), Income Tax Regs. A taxpayer will generally be released from the normal substantiation requirements if he establishes that (1) he at one time possessed adequate records, and (2) his loss of these records is due to circumstances beyond his control. Sec. 1.274-5(c)(5), Income Tax Regs. In such a situation, the taxpayer is required to reasonably reconstruct his expenditures. Gizzi v. Commissioner [Dec. 33,490], 65 T.C. 342, 345 (1975); Neece v. Commissioner [Dec. 42,951(M)], T.C. Memo. 1986-121.
Petitioners testified that a wind and hail storm destroyed the storage shed in which they maintained their 1986 records. At trial, petitioners provided copies of insurance reports documenting the destruction of the shed. We are satisfied that petitioners' failure to provide records stems from the destruction of the storage shed in while such records were stored. However, with regard to their Schedule C expenses, petitioners have failed to attempt to reasonably reconstruct their records. See Gizzi v. Commissioner, supra at 345. Despite having several years to contact third-party payees, the record contains no evidence of petitioners' attempting to obtain verification of any of the aforementioned expenses. Further, petitioners did not provide any information regarding the dates, amounts, and payees of their individual expenses. While it is within our purview to estimate the amount of the allowable deductions for many of the expenses claimed, Cohan v. Commissioner [2 USTC ¶ 489], 39 F.2d 540 (2d Cir. 1930), we must have some basis on which an estimate may be made, Vanicek v. Commissioner [Dec. 42,468], 85 T.C. 731, 743 (1985). Here, except for petitioners' self-serving testimony, which we are not required to accept, there is no basis on which an estimate may be made. Accordingly, we sustain respondent's determination regarding petitioners' 1986 Schedule C expenses.
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