Woodall v. C.I.R.

• Court: Court of Appeals for the Fifth Circuit
• Decided: June 12, 1992
• Docket: 91-4572
• Status: Published

Opinion

IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

No. 91-4572

PHYLLIS A. WOODALL and JEANNIE S. COUTTA, Petitioners,

versus

COMMISSIONER OF INTERNAL REVENUE, Respondent.

Appeal from a Decision of the United States Tax Court

(June 12, 1992)

Before WILLIAMS and HIGGINBOTHAM, Circuit Judges, and McNAMARA,* District Judge.

HIGGINBOTHAM, Circuit Judge:

Phyllis Woodall and Jeannie Coutta appeal a Tax Court judgment

finding additional taxes due in their 1982, 1983, and 1984 tax

years. The dispute arises out of fire losses to two partnership

assets presenting issues of valuation and accounting for income.

We affirm.

I.

Woodall and Coutta were equal partners in El Paso

Cosmopolitan, a partnership operating two nightclubs, the Naked

Harem Show Bar and the El Paso Cosmopolitan Topless Show Bar. On

* District Judge of the Eastern District of Louisiana, sitting by designation. April 5, 1982, the Cosmopolitan suffered extensive fire damage.

Woodall estimated the value of the partnership assets destroyed at

$90,000. The partnership pursued an insurance claim, but the

insurer was insolvent and the partnership had no reasonable

prospect of recovery by the end of 1982. The partnership claimed

a deduction of $78,441 for the fire loss at the Cosmopolitan on its

1982 return. However, the schedule L balance sheet attached to the

return, prepared by taxpayers' accountant, stated that the adjusted

basis of all depreciable partnership assets at the beginning of

1982 was only $8,541.

On April 21, 1982, the Naked Harem sustained extensive fire

damage. The partnership filed an insurance claim of $122,500, but

received only $50,000 from the receivership estate of the insurance

company. During 1983, the partnership spent $25,272 repairing fire

damage at the Naked Harem and purchased replacement assets

totalling $13,093. In August 1983, the partnership purchased the

land, building and improvements at 6345 Alameda for $245,000. The

partnership reported the $50,000 insurance recovery as taxable

income on its 1983 tax return.

Upon audit of the taxpayers' and the partnership's returns for

1982-1984, the IRS increased the partnership's taxable income for

each year, with excess income attributed equally to each partner.

The revenue agent used the bank deposits plus cash expenditures

method to reconstruct the gross receipts of the partnership and the

taxpayers. The revenue agent also disallowed $69,991 of the

partnership's claimed fire loss.

2 The IRS gave deficiency notices and Woodall and Coutta filed

petitions to the Tax Court.

II.

Internal Revenue Code § 165(a) allows a deduction for a loss

sustained during the taxable year not compensated for by insurance

or otherwise. The amount of available deductible loss is limited

to the adjusted basis of the property at the time of the loss. 26

U.S.C. § 165(b). The Tax Court determined that the adjusted basis

of the assets lost in the Cosmopolitan fire was $8,541 and

disallowed the partnership's deduction of losses above that amount.

The Tax Court valuation rested on the adjusted basis on the balance

sheet statement submitted by the partnership with its 1982 return.

The taxpayers argue first that the Tax Court could not rely

upon the balance sheet statement alone to prove that the adjusted

basis of the property was only $8,54l, relying upon Portillo v.

Commissioner, 932 F.2d 1128 (5th Cir. 1991). In Portillo, the IRS

issued a deficiency notice solely on the basis of an inconsistency

between the taxpayer's return and the figures on another party's

1099 form. We held that it was arbitrary and capricious to find a

deficiency without investigating or corroborating the figures in

the 1099 form provided by a third party. 932 F.2d at 1134. This

case does not raise the concern of Portillo, however, because the

IRS here relied upon the taxpayer's statement, not another's

statement.

Second, the taxpayers argue that they have disproved the

accuracy of the $8,541 figure because that figure would require

3 that deductions had been taken in prior years in excess of those

legally allowed under 26 U.S.C. § 1011. A taxpayer challenging the

IRS's disallowance of a deduction bears the burden of proof. Laney

v. Commissioner, 674 F.2d 342, 349 (5th Cir. 1982). The taxpayers

presented evidence at trial that the original cost basis in the

property was $93,569 and that the legally allowable depreciation in

prior years was $16,421. They argue that this evidence meets their

burden of proving the adjusted basis of their loss.

In Laney v. Commissioner, 674 F.2d 342 (5th Cir. 1982), we

held that where the IRS relied on facts in a schedule filled out

and signed by the taxpayer, the taxpayer could not meet its burden

of proof without financial records or other documentary evidence to

refute or contradict the reliability of the schedule. The

taxpayer's testimony that the facts in the schedule were untrue was

insufficient to rebut the tax return. Id.

The evidence here tending to contradict the schedule was

weaker than in Laney. Here, there was only Woodall's claim that

the property was worth more than $8,541. She did not state

unequivocally that the deductions had not been claimed in prior

years. She did not provide a credible explanation for the

allegedly inaccurate information on the schedule nor did she

present her tax returns for previous years to support her

contention. The taxpayers did not prove that the Tax Court's

findings were clearly erroneous.

Taxpayers suggest that even if they did take excessive

deductions in prior years, the proper result is to allow them the

4 1982 loss deduction and force the IRS to reopen their returns for

those prior years. The amount of deductible loss is limited to the

greater of the amount allowed as deductions or allowable as

deductions. 26 U.S.C. § 1016. An amount has been "allowed" in a

prior year if the Commissioner has not challenged it. Kilgroe v.

United States, 664 F.2d 11687, 1170 (10th Cir. 1981). Thus, the

Code contemplates allowed depreciations greater than those

allowable by law. The IRS need not reopen the taxpayer's past

returns but may use the lower adjusted basis resulting from excess

depreciation in calculating the 1982 allowable loss.

III.

The taxpayers assert that the $50,000 insurance recovery from

the Naked Harem fire was non-taxable because the partnership

purchased replacement property "similar or related in service or

use" to the property converted within the time period required by

26 U.S.C. § 1033. The Tax Court agreed that the insurance recovery

was non-taxable to the extent of the repairs made and the

replacement assets bought for the bar, $38,365 total, but held that

the purchase of the land, building and improvements at 6345 Alameda

did not qualify as property "similar or related in service or use."

The taxpayers rely on Davis Regulator Co. v. Commissioner, 36

B.T.A. 437 (1937) and Rev. Rul. 83-70, 1983-1 C.B. 189, for the

proposition that the purchase of a building can be a replacement

property for an involuntarily converted leasehold. This

proposition is sound. The taxpayers' problem is that they did not

suffer an involuntary conversion of their leasehold. The loss was

5 only to their improvements. In Davis Regulator, in contrast, the

taxpayer had been forced to sell its leasehold because of a threat

of condemnation. The fire in the Naked Harem did not force the

taxpayers to buy the nightclub buildings; their lease interest had

remained intact. In fact, taxpayers reopened the nightclub before

deciding to purchase the building. The purchase of the building

replaced no damaged property and the funds used for its purchase do

not fall within § 1033.

IV.

Finally, taxpayers argue that the calculation of taxable

income using the bank deposits plus cash expenditures method of

calculating income was arbitrary and capricious and therefore not

entitled to a presumption of correctness. Under the bank deposits

plus cash expenditures method, the IRS agent totals all deposits

into taxpayers' accounts during the year. The agent then looks at

the amount claimed by the taxpayer as business expenses for the

year and deducts from that amount all business checks written by

the taxpayer that year. Any amounts claimed as business expenses

but not accounted for by a business check are considered cash

expenditures. Total income is the amount of bank deposits plus

cash expenditures.

We have approved the use of this indirect method of proving

income, particularly where the incompleteness of the income records

makes other methods difficult. Mallette Bros. Const. Co. v.United

States, 695 F.2d 145, 148 (5th Cir. 1983) (IRS is authorized to use

whatever method seems appropriate to reconstruct taxpayer's

6 income). We see no reason why this method may not be used to

determine partnership income and the taxpayers have pointed to no

general problem with applying the method here. The burden is on

the taxpayer to demonstrate any unfairness or inadequacy of the

method. Price v. United States, 335 F.2d 671, 676 (5th Cir. 1964).

The taxpayers object specifically to the way their taxable

income was calculated. First, they argue that the agent double-

counted distributions made from the partnership to the individual

partners. The Tax Court found, however, that the agent excluded

amounts which were transferred from the partnership account to the

taxpayers' personal accounts. The agent counted only amounts that

were deposited directly from partnership cash proceeds into

personal accounts. If she had not counted these amounts they would

not have been counted at all because they were never deposited into

the partnership account. This calculation correctly reflects the

amount of income earned by the partnership.

Second, the taxpayers argue that the agent erred in not taking

into account the effects of capital contributions made by the

partners to the partnership during 1982. The IRS argues that the

taxpayers cannot point to any evidence in the financial records to

indicate that these contributions actually occurred. The taxpayers

assert that these capital contributions are evidenced by its 1982

tax return which claims partners' contributions to partnership

capital totaling $16,172 and that it would be inconsistent to hold

them bound by their statement of adjusted basis but not for their

capital contributions. This argument ignores the difference

7 between an admission against interest and a self-serving statement.

The revenue agent found no checks representing capital

contributions to the partnership in any of the taxpayers' personal

bank accounts. The taxpayers do not dispute this finding. Any

contributions in the form of property or undeposited cash would not

affect the income calculation. Therefore, the taxpayers have not

shown that the agent's computation of income is incorrect.

Third, the taxpayers argue that the agent erred in failing to

count as business expenses checks drawn on the partnership accounts

and made payable to "Cash." Taxpayers claim that this money was

used to pay business expenses to suppliers who would not take the

partnership's checks. The Tax Court found that the taxpayers had

presented no evidence to support their contentions other than

Woodall's "vague testimony" which it did not find credible. The

Tax Court's determination that these checks were not sufficiently

documented to be deductible as business expenses was not clearly

erroneous.

The judgment of the Tax Court is AFFIRMED.