T.C. Summary Opinion 2021-1
UNITED STATES TAX COURT
PAUL B. BRUNEAU AND KAREN L. BRUNEAU, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 7968-18S. Filed January 21, 2021.
Aksel Bagheri, for petitioners.
Albert B. Brewster II, for respondent.
SUMMARY OPINION
GUY, Special Trial Judge: This case was heard pursuant to the provisions
of section 7463 of the Internal Revenue Code in effect when the petition was
filed.1 Pursuant to section 7463(b), the decision to be entered is not reviewable by
1 Unless otherwise indicated, all section references are to the Internal (continued...)
Served 01/21/21 -2-
any other court, and this opinion shall not be treated as precedent for any other
case.
Respondent determined that petitioners (husband and wife) are liable for
Federal income tax deficiencies and penalties for the taxable years 2014 and 2015
(years in issue) as follows:
Accuracy-related penalty Year Deficiency sec. 6662(a)
2014 $32,692 $6,538 2015 33,558 6,711
Petitioners filed a timely petition for redetermination with the Court
pursuant to section 6213(a). They resided in California when the petition was
filed.
After concessions,2 the issues remaining for decision are (1) the amounts of
petitioners’ gross receipts for the years in issue, (2) whether petitioners are entitled
1 (...continued) Revenue Code (Code), as amended and in effect for the taxable years 2014 and 2015, and Rule references are to the Tax Court Rules of Practice and Procedure. All monetary amounts are rounded to the nearest dollar. 2 Petitioners concede that they are not entitled to deductions for “Other” expenses of $22,000 and $29,724 for 2014 and 2015, respectively; vehicle expenses of $20,358 and $13,800 for 2014 and 2015, respectively; utility expenses of $6,256 and $10,546 for 2014 and 2015, respectively; and meals and entertainment expenses of $1,707 for 2014. Other adjustments are computational only. -3-
to depreciation deductions of $23,204 and $37,091 for 2014 and 2015,
respectively, (3) whether petitioners are entitled to deductions for travel expenses
while away from home of $5,660 and $6,169 for 2014 and 2015, respectively, and
(4) whether petitioners are liable for accuracy-related penalties under section
6662(a) for the years in issue.
Background3
During the years in issue petitioners operated Dog’s Day Inn (DDI), a
kennel facility offering boarding and grooming services for dogs and cats. In
addition Mrs. Bruneau earned $35,000 to $50,000 during each of the years in issue
serving as a professional handler at dog shows and competitions.4
I. Petitioners’ Tax Returns
Petitioners filed joint Federal income tax returns for the years in issue and
attached Schedules C, Profit or Loss From Business, to those returns reporting
gross receipts and expenses attributable to DDI and Mrs. Bruneau’s dog show
activities.
3 Some of the facts have been stipulated. 4 Although Mrs. Bruneau was aware of the trial in this case, she did not appear or otherwise participate in the proceedings. -4-
A. Gross Receipts
1. 2014
Petitioners reported gross receipts of $385,178 on Schedule C for 2014.
The Internal Revenue Service (IRS) examined petitioners’ return, conducted a
bank deposits analysis, and determined that they had failed to report gross receipts
of $9,945.
2. 2015
Petitioners reported gross receipts of $421,169 on Schedule C for 2015.
The IRS examined petitioners’ return, performed a bank account analysis (an
examination technique that is less exacting than a bank deposits analysis), and
accepted the gross receipts as reported by petitioners.
Shortly before trial, petitioners asserted that they had overstated gross
receipts for 2015 by $36,745. Petitioners made some deposits to DDI’s account in
2015 from nontaxable sources, including proceeds from the repayment of a loan
and equipment sales, a refund from a utility company, and transfers from family
members.
B. Depreciation Deductions
In December 2000 petitioners paid $120,000 for the DDI property, which at
that time included a house (which petitioners occupied as their home), two dog -5-
kennels (one of which will be referred to as the old kennel), and several storage
buildings.
1. Improvements
In 2004 petitioners completed construction of a 7,000-square-foot kennel
(new kennel) which included an adjoining driveway, a small parking lot, and an
exercise area for dogs. Mr. Bruneau kept a handwritten ledger identifying
vendors, their contact information, and price estimates for work related to the new
kennel. In May 2005 petitioners received a supplemental property tax assessment
notice which increased the assessed value of the DDI property by $431,500. The
notice stated that the increased assessment was attributable to new construction on
the property.
In 2008 petitioners refurbished the old kennel and constructed a second
residence (duplex) on the DDI property. Mr. Bruneau estimated that petitioners
paid $67,000 to complete the old kennel project. He did not, however, testify as to
the cost of constructing the duplex. During the years in issue Mrs. Bruneau’s
father resided in one of the duplex units, and petitioners used the other unit for
storage. -6-
In or around 2009 petitioners erected a chain link fence on the DDI
property. Mr. Bruneau could not recall the amount that petitioners paid for the
fence.
In 2010 petitioners constructed a block wall on the DDI property. Mr.
Bruneau estimated that petitioners paid $67,000 for the block wall.
In 2012 petitioners added a garage and a carport to their home. Petitioners
stored a combination of personal effects and dog and cat crates in the garage. Mr.
Bruneau estimated that petitioners paid $45,000 for the garage and carport.
In June 2015 petitioners agreed to pay $139,104 to have solar panels
installed on the DDI property. Solar panels were installed on the new kennel and
on petitioners’ home.
2. Forms 4562
a. 2014
Petitioners attached Form 4562, Depreciation and Amortization, to their tax
return for 2014 and claimed deductions for section 179 expenses of $12,637, a
special depreciation allowance for qualified property placed in service during
2014 of $5,250, a modified accelerated cost recovery system (MACRS) deduction
for assets placed in service before 2014 of $17,691, and a deduction for 15-year
property placed in service during 2014 of $263. -7-
Respondent allowed the deduction for section 179 expenses (attributable to
a washer and dryer) but disallowed the remaining deductions totaling $23,204 for
lack of substantiation.
b. 2015
Petitioners attached Form 4562 to their tax return for 2015 and claimed
depreciation deductions of $37,091 comprising MACRS deductions for assets
placed in service before 2015 of $18,190, a deduction for 5-year property placed
in service in 2015 of $18,700, and a deduction for nonresidential real property of
$201. Respondent disallowed all depreciation deductions for 2015 for lack of
substantiation.
3. Missing Records
Petitioners did not provide direct evidence of the amounts they paid for the
various improvements to the DDI property described above or the amounts of
depreciation deductions they claimed for years before 2014. Mr. Bruneau
explained that petitioners’ former accountant was in possession of their original
records and that he had disappeared.
Petitioners produced a depreciation schedule that apparently was attached to
their California State income tax return for 2014. The schedule lists eight items,
including three items identified as “IMPROVEMENTS”, two items identified as -8-
“KENNEL”, a storage garage, a washer/dryer, and a kennel extension wall. The
schedule lists the dates that the items were acquired, cost basis, prior depreciation,
and current depreciation totaling $18,216.
C. Travel Expenses
Petitioners claim that they are entitled to deduct travel expenses of $5,660
and $6,169 for 2014 and 2015, respectively. The expenses purportedly relate to
Mrs. Bruneau’s trips to dog shows.
Petitioners produced a calendar with entries identifying the town or city
where Mrs. Bruneau served as a dog handler and the distance in miles that she
traveled by car to attend the show. Petitioners also produced schedules listing
hotels where they stayed on overnight trips, restaurants where they purchased
meals, and amounts they paid for meals and lodging. The record includes a few
checks which appear to represent payments to Mrs. Bruneau for dog handler
services.
II. Tax Return Preparation
Petitioners’ tax returns for the years in issue were prepared by a tax return
preparer. Mr. Bruneau acknowledged that petitioners did not review the
completed returns for accuracy and completeness before signing them. -9-
III. Section 6662(a) Penalties
On August 28, 2017, the revenue agent who examined petitioners’ returns
submitted Form 300, Civil Penalty Approval Form, to her immediate supervisor.
The Form 300 recommended the imposition of section 6662(a) penalties on the
theory that petitioners’ underpayments of tax were due to negligence. On
November 29, 2017, the revenue agent’s immediate supervisor sent a 30-day letter
to petitioners proposing adjustments to their tax returns for the years in issue,
including penalties under section 6662(a). On December 6, 2017, the revenue
agent’s immediate supervisor signed the aforementioned Form 300.
Discussion
The Commissioner’s determination of a taxpayer’s liability in a notice of
deficiency normally is presumed correct, and the taxpayer bears the burden of
proving that the determination is incorrect. Rule 142(a); Welch v. Helvering, 290
U.S. 111, 115 (1933).
I. Gross Receipts
Section 61(a)(2) defines gross income as all income from whatever source
derived, including gross income derived from business. Persons subject to Federal
income tax are required to keep records sufficient to establish gross income. See
sec. 6001; see also sec. 1.6001-1(a), Income Tax Regs. - 10 -
Where a taxpayer fails to maintain adequate records, the Commissioner is
authorized to compute the taxpayer’s income by any method which clearly reflects
income, including the bank deposits method. See sec. 446(b); Nicholas v.
Commissioner, 70 T.C. 1057, 1064 (1978). A bank deposit is prima facie
evidence of income. Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). The bank
deposits method assumes that all money deposited in a taxpayer’s bank account
during a given period constitutes taxable income, but the Commissioner must take
into account any known nontaxable source or deductible expense. DiLeo v.
Commissioner, 96 T.C. 858, 868 (1991), aff’d, 959 F.2d 16 (2d Cir. 1992).
Respondent analyzed DDI’s bank deposits and determined that petitioners
understated Schedule C gross receipts for 2014 by $9,945. Petitioners bear the
burden of proving that respondent’s determination of income using the bank
deposits method is erroneous. See Clayton v. Commissioner, 102 T.C. 632,
645-646 (1994).
At trial respondent conceded that petitioners demonstrated that they made
deposits of $7,122 to DDI’s account from nontaxable sources, leaving $2,823 in
dispute. Although petitioners maintain that they correctly reported gross receipts
of $385,178 for 2014, they failed to provide any probative evidence to account for - 11 -
the balance of the deposits remaining in dispute. Consequently, we conclude that
petitioners had unreported gross receipts of $2,823 for 2014.
Petitioners reported gross receipts of $421,169 for 2015--an amount that
closely aligned with total deposits to DDI’s account for that year. Shortly before
trial, petitioners asserted that their tax return preparer had overstated DDI’s gross
receipts by erroneously including $36,745 from nontaxable sources in the
calculation.
Gross receipts reported on a tax return are admissions that must be
overcome with cogent evidence. See, e.g., Pratt v. Commissioner, T.C. Memo.
2002-279. Petitioners maintain that they presented sufficient evidence to establish
that they overstated gross receipts. We disagree.
Petitioners rely primarily on a spreadsheet which was prepared by DDI’s
bookkeeper in 2017 (after petitioners filed their 2015 tax return) purportedly
showing that DDI collected a total of $330,934 for boarding, grooming, and
certain fees from its clients. Petitioners state that the spreadsheet “appears to be
an input of all of the invoices from the kennel.”
The Court is not persuaded that the 2017 spreadsheet provides a sound
baseline for determining petitioners’ gross receipts. DDI’s bookkeeper did not - 12 -
appear at trial and there is no evidence in the record explaining the process the
bookkeeper used in preparing the spreadsheet or why the document was prepared
after petitioners had filed their tax return for 2015. In sum, petitioners have
provided an incomplete and unreliable summary of their gross receipts.
Respondent’s determination that petitioners correctly reported gross receipts on
Schedule C for 2015 is sustained.
II. Deductions for Depreciation and Travel Expenses
Deductions are a matter of legislative grace, and the taxpayer generally
bears the burden of proving entitlement to any deduction 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). A taxpayer must substantiate deductions
claimed by keeping and producing adequate records that enable the Commissioner
to determine the taxpayer’s correct tax liability. Sec. 6001; Hradesky v.
Commissioner, 65 T.C. 87, 89-90 (1975), aff’d per curiam, 540 F.2d 821 (5th Cir.
1976); Meneguzzo v. Commissioner, 43 T.C. 824, 831-832 (1965). A taxpayer
claiming a deduction on a Federal income tax return must demonstrate that the
deduction is allowable pursuant to a statutory provision and must further
substantiate that the expense to which the deduction relates has been paid or
incurred. Sec. 6001; Hradesky v. Commissioner, 65 T.C. at 89-90. - 13 -
Under section 162(a), a deduction is allowed for ordinary and necessary
expenses paid or incurred during the taxable year in carrying on any trade or
business. Whether an expenditure satisfies the requirements for deductibility
under section 162 generally is a question of fact. See Commissioner v. Heininger,
320 U.S. 467, 475 (1943). An ordinary expense is one that commonly or
frequently occurs in the taxpayer’s business, Deputy v. du Pont, 308 U.S. 488, 495
(1940), and a necessary expense is one that is appropriate and helpful in carrying
on the taxpayer’s business, Commissioner v. Heininger, 320 U.S. at 471;
sec. 1.162-1(a), Income Tax Regs.
When a taxpayer establishes that he or she paid or incurred a deductible
expense but fails to establish the amount of the deduction, the Court may
sometimes estimate the amount allowable as a deduction. Cohan v.
Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930); Vanicek v. Commissioner,
85 T.C. 731, 742-743 (1985). There must be sufficient evidence in the record,
however, to permit the Court to conclude that a deductible expense was paid or
incurred in at least the amount allowed. Williams v. United States, 245 F.2d 559,
560 (5th Cir. 1957). - 14 -
A. Depreciation Expenses
Section 167 permits as a depreciation deduction a reasonable allowance for
the exhaustion and wear and tear of property used in a trade or business or held for
the production of income.5 A depreciation deduction is determined by reference to
the adjusted basis of the property, the applicable depreciation method, the
applicable recovery period, and the applicable convention. Secs. 167(c)(1), 168;
Hosp. Corp. of Am. & Subs. v. Commissioner, 109 T.C. 21, 45 (1997).
A taxpayer is entitled to depreciate an asset once it is placed into service for
its intended purpose and may depreciate that asset only until it is retired from
service. See Wilson v. Commissioner, T.C. Memo. 2002-61, aff’d, 71 F. App’x
623 (9th Cir. 2003); sec. 1.167(a)-10(b), Income Tax Regs. To prove entitlement
to a depreciation deduction, a taxpayer must establish the property’s depreciable
basis by showing the cost of the property, its useful life or recovery period, and
any previously allowable depreciation. See Cluck v. Commissioner, 105 T.C. 324,
337 (1995).
Petitioners claim that they are entitled to depreciation deductions of $23,204
and $37,091 for 2014 and 2015, respectively, related to the new kennel,
5 Sec. 280A generally disallows deductions for expenses with respect to a dwelling unit used by the taxpayer during the taxable year as a residence. - 15 -
rehabilitation of the old kennel, the block wall, the garage and carport, the duplex,
the chain link fence, and the solar panels. Petitioners offered very little reliable,
objective evidence, however, of the depreciable basis (the cost of improvements)
or previously allowable depreciation in respect of the various improvements in
question. Mr. Bruneau offered estimates of the dates of completion and the
amounts that petitioners paid for the various improvements, a supplemental
property assessment notice, and a 2014 depreciation schedule in support of their
position.
Depreciation schedules prepared to facilitate filing a tax return are merely
another form of the taxpayer’s claim to a deduction and are insufficient to satisfy
the taxpayer’s burden of proof. See, e.g., Holden v. Commissioner, T.C. Memo.
2015-131, at *65. Moreover, petitioners did not provide income tax returns for
years before 2014 to demonstrate previously allowable depreciation.
In sum, the evidence that petitioners offered is insufficient to substantiate
the depreciation deductions in dispute, or to permit the Court to estimate the
amount allowable as a deduction under the Cohan doctrine. Although we accept
Mr. Bruneau’s testimony that petitioners’ former accountant disappeared with
their tax records, we nevertheless are obliged on this record to sustain
respondent’s determination disallowing the depreciation deductions in dispute. - 16 -
B. Travel Expenses
Section 274(d) prescribes more stringent substantiation requirements to be
met before a taxpayer may deduct certain categories of expenses, including travel
expenses, meals and lodging while away from home, and expenses with respect to
listed property as defined in section 280F(d)(4). See Sanford v. Commissioner, 50
T.C. 823, 827 (1968), aff’d per curiam, 412 F.2d 201 (2d Cir. 1969). The term
“listed property” includes passenger automobiles. Sec. 280F(d)(4)(A)(i).
To satisfy the requirements of section 274(d), a taxpayer generally must
maintain adequate records or produce sufficient evidence corroborating his or her
own statement which, in combination, are sufficient to establish the amount, date
and time, and business purpose for each expenditure. Sec. 1.274-5T(b)(2), (6),
(c)(1), Temporary Income Tax Regs., 50 Fed. Reg. 46014-46017 (Nov. 6, 1985).
Section 1.274-5T(c)(2), Temporary Income Tax Regs., 50 Fed. Reg. 46017-46018
(Nov. 6, 1985), provides in relevant part that “adequate records” generally consist
of an account book, a diary, a log, a statement of expense, trip sheets, or a similar
record made at or near the time of the expenditure or use, along with supporting
documentary evidence. The Court may not use the rule established in Cohan v.
Commissioner, 39 F.2d at 543-544, to estimate expenses covered by section - 17 -
274(d). Sanford v. Commissioner, 50 T.C. at 827; sec. 1.274-5T(a), Temporary
Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6, 1985).
Petitioners claim that they are entitled to deduct travel expenses for 2014
and 2015 related to Mrs. Bruneau’s trips to various dog shows. Petitioners rely on
a calendar with notations identifying travel dates and vehicle mileage, a
spreadsheet listing expenses for meals and lodging, and related bank records.
As previously mentioned, Mrs. Bruneau did not appear at trial. Other than
Mr. Bruneau’s testimony, there is little evidence in the record reflecting payments
to Mrs. Bruneau for dog handler services and the accuracy and reliability of Mrs.
Bruneau’s calendar. To the extent that we are able to link certain travel dates and
related expenses with payments to Mrs. Bruneau for dog handler services, we
conclude that petitioners have adequately substantiated that Mrs. Bruneau drove
532 miles and paid expenses of $1,074 for business purposes in 2014. There is
insufficient evidence to support a finding that petitioners are entitled to a
deduction for travel-related expenses for 2015.
Section 6662(a) and (b)(1) imposes an accuracy-related penalty equal to
20% of the amount of any underpayment of tax that is due to the taxpayer’s
negligence or disregard of rules or regulations. An underpayment is defined - 18 -
generally as the difference between the tax imposed on the taxpayer and the tax
reported on the tax return. Sec. 6664(a).6
The term “negligence” includes any failure to make a reasonable attempt to
comply with the provisions of the Code. Sec. 6662(c). Negligence includes any
failure by the taxpayer to keep adequate books and records or to substantiate items
properly. See sec. 1.6662-3(b)(1), Income Tax Regs.
With respect to a taxpayer’s liability for any penalty, section 7491(c) places
on the Commissioner the burden of production, thereby requiring the
Commissioner to come forward with sufficient evidence indicating that it is
appropriate to impose the penalty. Higbee v. Commissioner, 116 T.C. 438,
446-447 (2001). The Commissioner’s burden of production includes showing that
the immediate supervisor of the IRS employee who made the “initial
determination” of a penalty (including a section 6662(a) penalty) approved that
penalty in compliance with section 6751(b)(1). Clay v. Commissioner, 152 T.C.
223, 248 (2019); see also Chai v. Commissioner, 851 F.3d 190, 221 (2d Cir.
2017), aff’g in part, rev’g in part T.C. Memo. 2015-42. Once the Commissioner
6 Consistent with this definition, we reject petitioners’ claim that any underpayments for the years in issue should be computed without regard to tax related to computational adjustments. - 19 -
meets his burden of production, the taxpayer must come forward with persuasive
evidence that the Commissioner’s determination is incorrect. Rule 142(a).
Respondent has met his burden of production. As discussed above,
petitioners failed to maintain adequate books and records needed to properly
substantiate most of the expenses that they reported on Schedules C. In addition,
the requirements of section 6751(b) have been met given that the immediate
supervisor of the revenue agent who first proposed to impose the section 6662(a)
penalties in question signed the 30-day letter sent to petitioners on November 28,
2017. See, e.g., Cuthbertson v. Commissioner, T.C. Memo. 2020-9, at *68-*69.
Section 6664(c)(1) provides an exception to the imposition of a penalty if it
is shown that there was reasonable cause for the underpayment and the taxpayer
acted in good faith. Reliance on the advice of a professional tax adviser may
constitute reasonable cause and good faith, but a taxpayer must prove that: (1) the
adviser was a competent professional who had sufficient expertise to justify
reliance, (2) the taxpayer gave the adviser the necessary and accurate information,
and (3) the taxpayer actually relied in good faith on the adviser’s judgment.
Neonatology Assocs. P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d, 299
F.3d 221 (3d Cir. 2002). - 20 -
Petitioners did not offer a meaningful defense to the imposition of the
accuracy-related penalties. Although Mr. Bruneau asserted that petitioners relied
on their tax return preparer to properly prepare their tax returns, he acknowledged
that they did not review the returns for accuracy and completeness before signing
them. Petitioners have failed to show that they reasonably attempted to ascertain
the correctness of the disallowed deductions or to comply with the provisions of
the Code. Accordingly, we sustain respondent’s determination that petitioners are
liable for penalties under section 6662(a).
To reflect the foregoing,
Decision will be entered under
Rule 155.