Reynolds, Charles v. CIR

In the
United States Court of Appeals
For the Seventh Circuit
____________
No. 00-2966
CHARLES REYNOLDS and BEATRICE REYNOLDS,
Petitioners-Appellants,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellee.
____________
Appeal from the United States Tax Court
No. 12112-97—John F. Dean, Special Trial Judge.
____________
ARGUED NOVEMBER 30, 2001—DECIDED JULY 18, 2002
____________
Before FLAUM, Chief Judge, CUDAHY, and MANION,
Circuit Judges.
CUDAHY, Circuit Judge. This dispute arises from certain
tax deductions claimed by Charles and Beatrice Reynolds
on their 1993 and 1994 tax returns. The Internal Revenue
Service (IRS) challenged the deductibility of certain ex-
penses related to a family farm business, rental properties
and to Charles Reynolds’ private law practice, which is, for
better or worse, a sideline from his full-time employment
as an IRS supervisor.1 During the pendency of this dis-
pute, the Reynolds received two brief letters from the IRS
1
Reynolds recently retired from the IRS.
2 No. 00-2966
stating that they had no outstanding liability for the 1993
and 1994 tax years. The Reynolds asserted that these let-
ters were binding admissions by the IRS, thus estopping the
agency from pursuing any further action against them. The
U.S. Tax Court rejected this argument and ruled on the
merits, allowing some of the deductions and disallowing
others. In addition, pursuant to 29 U.S.C. § 6662(a), the Tax
Court upheld a 20% accuracy-related penalty because it
found that some of the remaining errors were the result of
negligence.
The Reynolds appeal the following: (1) the evidentiary
weight given to the no-liability letters, (2) the classification
of certain legal defense costs as personal costs rather than
as business expenses related to Charles Reynolds’ private
law practice, (3) the denial of various automobile and travel
expenses related to the private law practice, farming ac-
tivity and the rental properties, and (4) the imposition of
the accuracy-related penalties. We affirm the judgment of
the Tax Court.
I.
Charles Reynolds joined the IRS in 1976, where he
worked as a revenue officer in the Chicago office. Several
years later, Reynolds graduated from law school and was
promoted to a supervisory position, which involved a case-
load of taxpayer audits. In 1987 and 1988, Reynolds re-
ceived permission from the IRS to practice law in addition
to his primary employment with the IRS. However, in 1992,
the IRS commenced an investigation of Reynolds spring-
ing from concerns that he may have been conducting his
private law practice during his workday at the IRS. To de-
fend himself, Reynolds hired a major Chicago law firm and
incurred legal expenses. The investigation was officially ter-
minated in 1995.
During 1993 and 1994, which is the time period relevant
to this dispute, Charles Reynolds operated a small part-
No. 00-2966 3
time law practice. These efforts were limited to a few real
estate closings and related activities. In 1993, Reynold’s
Schedule C for this law practice reported gross receipts
of only $700.2 However, he claimed a net loss of $6,271.
His deductions included $2,380 for legal fees related to the
IRS investigation of certain questionable on-the-job activi-
ties. Similarly, in 1994, Reynold’s Schedule C reported gross
receipts of $450 with a net loss of $10,255. This amount
included $5,615 in legal fees related to the ongoing inves-
tigation. In a subsequent audit, the IRS disallowed the
business deduction of the legal expenses, ruling that they
should instead be categorized as itemized personal expenses
on Schedule A and thus deductible to the extent they
exceeded the 2% “floor” limitation of 26 U.S.C. § 67(a).
In addition to the reclassification of the legal expense,
IRS auditors also denied various other deductions, includ-
ing automobile and travel expenses allegedly related to the
law practice, to a family farm and to rental properties. Only
the auto and travel expenses, however, are currently be-
fore us on appeal. From our own inspection of the record, we
estimate the total amount of the deductions now in dis-
pute to be approximately $3,359.3 Included in this amount
2
This case involves a discussion of various tax forms, or “Sched-
ules,” used in the preparation of a federal tax return. Schedule C
is used to calculate a profit or loss from a sole proprietorship—
e.g., a law practice. Schedule A is used to itemize various personal
expenses that are deductible under federal law. Schedule E is
used to state supplemental income or loss from various other
activities—e.g., rental income from real property. Schedule F is
used to state a profit or loss from farming activity.
3
Neither party in this case provides an intelligible summary of
precisely which automobile and travel deductions are now on
appeal nor do they give us the total amount of the claimed de-
ductions. Moreover, during the proceedings below, the Tax Court
(continued...)
4 No. 00-2966
are travel and automobile expenses allegedly incurred by
Charles Reynolds in the course of his law practice, includ-
ing depreciation of a 1988 Toyota Camry. Similarly, the IRS
denied travel and automobile expenses related to rental
property owned by the Reynolds in Indiana, Kentucky and
Virginia, and travel to Florida to evaluate a real estate
development project that never materialized. Finally, the
IRS denied travel and automobile expenses incurred in a
trip to a family-owned farm in Kentucky, including the de-
preciation of a 1994 Ford van, which was supposedly used
“to haul tillers, plows and farm tools from Virginia to Ken-
tucky and for use in the operation of the farm.”4 Although
the Reynolds did not keep a log of specific trips and the
3
(...continued)
discovered that the disputed travel, meals and automobile ex-
penses, including depreciation of various cars owned by the
Reynolds, had been consolidated on either Schedules C or E rather
than spread across Schedules C, E and F to reflect the costs in-
curred in each activity (i.e., law practice, rental properties or
farming). The Reynolds attempted to cure this problem by sub-
mitting additional documents that reflected a more precise break-
down. Although the Reynolds correctly point out that all expenses
listed on Schedules C, E and F are “above-the-line” deductions,
and thus their assignment to a particular Schedule has no effect
on their total tax liability, Appellant’s Br. at 27, they seem to
forget that “the taxpayer[ ] bears the burden of showing a right to
the business deduction.” A.E. Staley Mfg. Co. v. Commissioner,
119 F.3d 482, 486 (7th Cir. 1997) (citing INDOPCO, Inc. v. Com-
missioner, 503 U.S. 79, 84 (1992)). It is astonishing that the
Reynolds fail to make a clear statement on the amount of the
automobile and travel deductions they are entitled to, especial-
ly since these deductions were disallowed by the Tax Court be-
cause of inadequate substantiation under 26 U.S.C. § 274(d). The
Reynolds apparently believe that, if their argument carries the
day, the U.S. Court of Appeals will do the math for them.
4
According to tax returns filed by the Reynolds, the family farm
generated $50 in revenues in 1993 and $1,745 in 1994. In both
years, the farm operated at a net loss.
No. 00-2966 5
mileage that corresponded with each money-making ac-
tivity, Charles Reynolds retained various receipts for gas,
maintenance and repairs, and during the subsequent au-
dit, he attempted to categorize each expense and to appor-
tion it to the appropriate activities.
Nonetheless, the IRS denied the automobile and travel
deductions on various grounds, including failure to comply
with the substantiation requirements of 26 U.S.C. § 274(d).
After the IRS had made several other adverse rulings that
are not pertinent to this appeal, the agency calculated de-
ficiencies of $4,732 and $3,092 for the 1993 and 1994 tax
years, respectively, together with corresponding accuracy-
related penalties of $946 and $618, respectively.
In August of 1997, the Reynolds petitioned the U.S. Tax
Court for a redetermination of their 1993 and 1994 tax
liability. In March of 1998, while this matter was still pend-
ing before the Tax Court, the Reynolds apparently sent a
letter of inquiry to the IRS problem resolution office in Kan-
sas City, Missouri, with respect to their 1993 and 1994 tax
liabilities. It is important to note that this inquiry was not
directed to the district counsel for the IRS, who was rep-
resenting the respondent in the ongoing dispute before
the Tax Court. A month later, the Reynolds received two
short letters from the IRS, one pertaining to 1993 and the
other to 1994, that were identically worded with the ex-
ception of the specific tax amounts peculiar to each. After
listing credit adjustments for each year, both letters listed
“the amount you now owe” as “none.”
In April 1999, the case went to trial, and the Reynolds
asserted that the IRS correspondence was tantamount to
a binding admission by the government that estopped it
from litigating the present case. The Tax Court rejected
this argument as contrary to well-established law. The
court went on to consider various testimony and exhibits,
issuing a decision in part for the Reynolds and in part for
6 No. 00-2966
the IRS. The restated liability was $2,422 and $1,937 for
the 1993 and 1994 tax years, respectively, together with
corresponding accuracy-related penalties of $484.40 and
$387.40, respectively. Although the amount in controversy
in the case is relatively small, the Reynolds assert that this
appeal is being brought “to purge the taint on [Charles
Reynolds’] reputation arising from the negligence penalty
assessed against him.” We agree that money is not the
measure of all things worth fighting for, and the issues
raised here are, for the most part, serious.
II.
Pursuant to 28 U.S.C. § 2072, decisions of U.S. Tax Court
are reviewable by this court. See 28 U.S.C. § 2072. The
Reynolds present four issues for review: (1) Did the Tax
Court err when it refused to consider the written no-
tices sent to the Reynolds in relation to their 1993 and
1994 tax liability? (2) Did the Tax Court err in classifying
Charles Reynolds’ legal defense expenditures as § 67(a)
itemized personal deductions rather than as § 162(a) busi-
ness expenses? (3) Did the Tax Court err in ruling that the
Reynolds had failed to adequately substantiate their
automobile and travel-related expenses on Schedule C (law
practice), Schedule E (rental properties) and Schedule F
(farming business), as required by § 274(d)? (4) Did the
Tax Court err in sustaining a § 6662(a) accuracy penalty
against the Reynolds for negligent underpayments of their
1993 and 1994 taxes?
Before considering each issue in turn, we note that a de-
cision of the Tax Court is subject to the same standards of
review “that we apply to district court determinations in a
civil bench trial: We review factual determinations, as well
as applications of legal principles to those factual determi-
nations, only for clear error.” Cline v. Commissioner, 34
F.3d 480, 484 (7th Cir. 1994); accord Toushin v. Commis-
No. 00-2966 7
sioner, 223 F.3d 642, 645-46 (7th Cir. 2000); Fruit of the
Loom, Inc. v. Commissioner, 72 F.3d 1338, 1343 (7th Cir.
1996). However, deficiencies determined by the Commis-
sioner are presumed to be correct and the taxpayer bears
the burden of proving otherwise. Pittman v. Commissioner,
100 F.3d 1308, 1313 (7th Cir. 1997).
A.
The first issue we address is whether the Tax Court erred
when it refused to treat the two no-liability letters from the
IRS (pertaining to the 1993 and 1994 tax years, respective-
ly) as binding admissions. The Reynolds claim that these
two documents are “uncontroverted binding admissions
of no deficiency,” thus mandating a judgment in their fa-
vor. However, the cases relied upon by the Reynolds in this
regard all deal with “judicial admissions,” which enter the
litigation either through the pleadings or under Rule 36 of
the Federal Rules of Civil Procedure. See, e.g., Kohler v.
Leslie Hindman, Inc., 80 F.3d 1181, 1185 (7th Cir. 1996)
(“When a party in a lawsuit makes an admission in its
pleadings or in its answer to a request for admissions, it
makes a judicial admission that can determine the outcome
of that lawsuit.” (citing Fed. R. Civ. P. 36(b))); Keller v.
United States, 58 F.3d 1194, 1199 n.8 (7th Cir. 1995) (“Ju-
dicial admissions are formal concessions in the plead-
ings, or stipulations by a party or its counsel, that are
binding upon the party making them. They may not be con-
troverted at trial or on appeal. . . . [They] have the effect
of withdrawing a fact from contention.” (quotations omit-
ted)).
Although a judicial admission has the effect of settling
an issue of fact for the purposes of the current litigation,
nothing of that exalted significance is present here. The
alleged admissions in this case were not furnished by the
IRS as part of the record before the Tax Court. In fact, the
8 No. 00-2966
weight to be accorded these letters appears to be less than
leaden.
The story unfolds as follows. The Tax Court scheduled the
matter before us now for a trial to commence on March 2,
1998. On the day of trial, the district counsel for the IRS
learned that the Reynolds had been subject to a premature
deficiency assessment for the 1993 and 1994 tax years and
motioned the Tax Court to return the case to its general
trial docket. According to the court transcript for that date,
the parties appeared to be close to settlement. The Reynolds
offered no objection to the government’s motion, and a
continuance was granted. Shortly thereafter, the Reynolds
apparently sent an inquiry to the IRS problem resolution
office in Kansas City, Missouri. On April 13, 1998, that of-
fice generated the two no-liability letters, which respec-
tively credited the Reynolds’ 1993 and 1994 tax years in
the exact amount at issue before the Tax Court. Both of
these very short letters contained the following sentence:
“This [action] is the result of your correspondence of March
18, 1998.” However, a copy of the March 18, 1998 letter is
not part of the record, presumably because it was sent to
the IRS problem resolution office in Kansas City. If the
Reynolds wanted the IRS to stipulate or to admit that
the couple owed no taxes for 1993 and 1994, they should
have directed their correspondence to the district counsel
for the IRS, who was based in Chicago and apparently was
well known to the Reynolds through previous settlement
negotiations and court appearances. The Reynolds cannot
obtain a judicial admission on the cheap.
At most, the two no-liability letters are extrajudicial
admissions, which are admissible as evidence and may be
weighed by the factfinder according to their probative value.
See Murrey v. United States, 73 F.3d 1448, 1455 (7th Cir.
1996) (distinguishing between a “judicial admission” and an
“extrajudicial admission”); Keller, 58 F.3d at 1199 n.8
(distinguishing between “judicial admission” and other ad-
No. 00-2966 9
missions which are treated as evidence). In the case before
us, the letters have virtually no probative value. The letters
appear to have been computer generated and do not ref-
erence in any way the litigation that has been pending
before the Tax Court. The letters state that the Reynolds’
“account” was “adjusted.” Because the Reynolds could not
be lawfully assessed with a tax deficiency until the Tax
Court issued a decision favorable to the IRS, see 26 U.S.C.
§ 6213(a), these letters most likely reflect an adjustment
for a premature deficiency assessment. Unfortunately, we
don’t know what information the IRS office in Kansas
City was acting upon because the correspondence which
prompted the IRS reply is not part of the record.
Further, the settlement or closure of a civil tax dispute
with the IRS is a matter controlled by statute. See 26 U.S.C.
§§ 7121 (closing agreements), 7122 (compromises). These
provisions provide the exclusive method for settling civil tax
disputes with finality. See Brooks v. United States, 833 F.2d
1136, 1145 (4th Cir. 1987) (holding that “[s]ection 7122 is
the exclusive method by which tax cases may be compro-
mised”); Whitney v. United States, 826 F.2d 896, 897-98 (9th
Cir. 1987) (holding that “section 7121 of the Internal Rev-
enue Code is the exclusive means whereby tax disputes can
be settled”); Hagadone v. Commissioner, 98 T.C.M. (RIA)
352 (“It is well established that as a general rule the Com-
missioner is finally and conclusively bound by an agreement
with a taxpayer only if the parties enter into a closing
agreement under the provisions of section 7121.”). The Tax
Court correctly observed that the record “is devoid of any
evidence that petitioners and respondent entered into a
valid closing or compromise agreement.” On the evidentiary
weight to be given to the no-liability letters, we are in
agreement with the Tax Court. The letters get the petition-
ers no closer to their goal.
10 No. 00-2966
B.
The next issue before us is whether the Tax Court erred
when it ruled that legal defense costs incurred by Charles
Reynolds during the 1993 and 1994 tax years were miscella-
neous itemized deductions, which are subject to the 2%
floor contained in 26 U.S.C. § 67(a), rather than business
expenses related to the private law practice, which are fully
deductible under 26 U.S.C. § 162(a). The legal costs at is-
sue here are related to the IRS investigation of Charles
Reynolds’ alleged on-the-job misconduct—i.e., that he may
have been conducting his private law practice during his
official hours of employment at the IRS.
The Reynolds’ primary argument is that Charles
Reynolds’ ability to practice law on a part-time basis had
to be approved through appropriate IRS channels. Thus,
an adverse ruling could have led to the withdrawal of
this approval and thus terminated his practice of law. The
Reynolds also claim that an adverse ruling would have
negatively affected Charles Reynolds’ legal reputation,
which would have caused him to lose law-related business.
Following this logic, the Reynolds maintain that all of
the legal defense costs for 1993 and 1994 ($5,615 and
$2,380, respectively) were properly listed as Schedule C
business expenses.
In response, the government correctly argues that this
issue is governed by the “origin of the claim” doctrine,
which was first articulated by the Supreme Court in United
States v. Gilmore, 372 U.S. 39 (1963). In Gilmore, the tax-
payer attempted to deduct substantial legal expenses in-
curred in protracted divorce litigation with his estranged
wife as a “business” expense related to income-producing
property rather than as a “personal” expense. The taxpayer
justified his position by arguing that the divorce litigation
involved the disposition of three car dealerships owned
by the taxpayer. He contended that the conservation of
No. 00-2966 11
these income-producing assets depended upon his ability to
retain a controlling stock interest in them.5 Moreover, if
certain scandalous allegations were proven to be true, the
taxpayer’s franchisor might have grounds to cancel his
dealerships. The Court rejected the taxpayer’s position,
holding:
[T]he characterization, as “business” or “personal,” of
the litigation costs of resisting a claim depends on
whether or not the claim arises in connection with the
taxpayer’s profit-seeking activities. It does not depend
on the consequences that might result to a taxpay-
er’s income-producing property from a failure to de-
feat the claim, for . . . “that would carry us too far”
and would not be compatible with the basic lines of
expense deductibility drawn by Congress.
372 U.S. at 48 (emphasis in original) (footnote omitted)
(quoting Lykes v. United States, 343 U.S. 118, 125 (1952)).
In the case before us, the origin of the claim lies in
Charles Reynold’s conduct as an IRS employee, not in his
trade or business as a self-employed attorney. Charles
Reynolds incurred these legal costs because an IRS investi-
gation had been commenced to determine whether he was
5
Gilmore addressed the deductibility of legal expenses related
to the conservation of income-producing property under §§ 23(a),
24(a) of the 1939 Code, and its successor statutes, 26 U.S.C.
§§ 212, 262, of the 1954 Code. See 372 U.S. at 40 & n.3. However,
it is well settled in that the holding of Gilmore also applies to the
deductibility of legal expenses under § 162(a). See Anchor Coupl-
ing Co., Inc. v. United States, 427 F.2d 429, 433 (7th Cir. 1970)
(applying Gilmore to determine deductibility of legal expenses
under § 162(a)); see also Dana Corp. v. United States, 174 F.3d
1344, 1350-51 (Fed. Cir. 1999) (same); Kopp’s Co. v. United States,
636 F.2d 59, 60-61 (4th Cir. 1980) (same); Nadiak v. Commis-
sioner, 356 F.2d 911, 912 (2d Cir. 1966) (same); Berry Petroleum
Co. v. Commissioner, 104 T.C. 584, 618-22 (1995) (same).
12 No. 00-2966
practicing law during his prescribed hours of employment
at the IRS. Under Gilmore, the business-related conse-
quences that may flow from the IRS’s inquiry—that it may
result in withdrawal of IRS approval for the part-time law
practice or damage to Charles Reynolds’ professional rep-
utation—do not control the question whether the fees are
deductible as a business expense. Since the taxpayer bears
the burden of showing that he has a right to a business
deduction, A.E. Staley Mfg. Co., 119 F.3d at 486, and no
additional arguments have been advanced on this issue, the
Reynolds cannot prevail. The disputed legal fees are
properly classified as miscellaneous itemized deductions,
which are subject to the 2% floor contained in § 67(a).
C.
The Reynolds next assert that the Tax Court erred when
it denied deductions for various automobile and travel
expenses that were purportedly made in connection with
the law practice, the rental properties or farming activity.
The Tax Court ruled that none of the expenses at issue
were deductible because the Reynolds had failed to satisfy
the substantiation requirements of 26 U.S.C. § 274(d). At
the outset, we note that a determination that a taxpayer
has failed to come forward with sufficient evidence to sup-
port a deduction, including a failure to comply with the
§ 274(d) substantiation requirements, is generally viewed
as a finding of fact that is reviewed for clear error. See, e.g.,
Yoon v. Commissioner, 135 F.3d 1007, 1012, 1016 (5th Cir.
1998) (reviewing § 274(d) ruling for clear error); Buelow v.
Commissioner, 970 F.2d 412, 415 (7th Cir. 1992) (“The tax
court determination that a taxpayer has failed to come for-
ward with sufficient evidence to support a deduction is a
factual finding subject to reversal only if found to be clearly
erroneous.”). The tax code precludes a deduction for various
enumerated items, including auto and travel expenses,
No. 00-2966 13
unless a taxpayer substantiates “by [1] adequate records or
[2] by sufficient evidence corroborating the taxpayer’s own
statement” the following five elements: the amount, date,
time, place and business purpose of the expense. 26 U.S.C.
§ 274(d); see also Dowell v. United States, 522 F.2d 708, 714
(5th Cir. 1975).
Here, the Reynolds fall far short of the necessary show-
ing. Based on the regulations under § 274(d), the Reynolds
cannot avail themselves of the “adequate records” language
of § 274(d) because they did not maintain logs for each
vehicle in their household to reflect their use in the law
practice, rental property management or farming activities.
See 26 C.F.R. § 1.274(d)(2) (1993) (stating that substan-
tiation by adequate records requires a taxpayer “to main-
tain an account book, diary, log, statement of expense,
trip sheets, or similar record” that is made “at or near the
time of the expenditure or use”). Although Treasury reg-
ulations implementing § 274(d) clearly state that “adequate
records” are not the only method of establishing eligibility,
alternative methods are disfavored—and for good reason.
At the risk of the reader’s eyes glazing over, we will quote
at length the “rules of substantiation” as they appeared
in the 1993 Code of Federal Regulations,6 especially since
they bear on the accuracy-related penalties that the
Reynolds also appeal:
[A] taxpayer must substantiate each element of an
expenditure or use . . . by [1] adequate records or [2]
by sufficient evidence corroborating his own state-
ment . . . . A contemporaneous log is not required, but
a record of the elements of an expenditure or of a
6
The 1993 version governs the 1993 tax year and could have
provided guidance to the Reynolds in their recordkeeping efforts.
Based on our own brief review, however, the 2002 version of this
regulation is substantially the same as the one in effect in 1993.
14 No. 00-2966
business use of listed property made at or near the time
of the expenditure or use, supported by sufficient
documentary evidence, has a high degree of credibility
not present with respect to a statement prepared sub-
sequent thereto when generally there is a lack of ac-
curate recall. Thus, the corroborative evidence required
to support a statement not made at or near the time
of the expenditure or use must have a high degree of
probative value to elevate such statement or evidence
to the level of credibility reflected by a record made
at or near the time of the expenditure or use supported
by sufficient documentary evidence. The substantiation
requirements of section 274(d) are designed to encour-
age taxpayers to maintain the records, together with
documentary evidence, as provided in paragraph (c)(2)
of this section [entitled “Substantiation by adequate
records”].
26 C.F.R. § 1.274-5T(c)(1) (1993) (emphasis added).
The implications of this passage are unmistakable. Com-
plete, contemporaneous records are the preferred method
of substantiation. Taxpayers who pursue alternative meth-
ods will have to present evidence that is equally credible
and probative, which will be difficult.
When a taxpayer cannot substantiate his deduction with
“adequate records,” the Treasury Regulations specifically
lay out the method for substantiation “by other sufficient
evidence.” A taxpayer must establish each element of a
§ 274(d) business expense “(A) By his own statement,
whether written or oral, containing specific information in
detail as to such element; and (B) By other corrobora-
tive evidence sufficient to establish such element.” § 1.274-
5T(c)(3)(i) (1993).
This alternate method was utilized by the Reynolds at
trial. Specifically, Charles Reynolds testified as to the
business purpose of each deduction and attempted to sub-
No. 00-2966 15
stantiate his account by presenting various documents that
purported to reconstruct the date, amount and proper
categorization of the claimed expenses. To prepare these
exhibits, Reynolds relied on voluminous receipts and can-
celled checks from the 1993 and 1994 tax years; a “represen-
tative” sample of these receipts was made available for
inspection and then submitted into the record.
The Tax Court ultimately found this testimony and evi-
dence unconvincing. For example, Charles Reynolds created
a two-page chart entitled “Reconstruction of Mileages Driv-
en,” which categorizes his 1993 auto expenses by month and
profit-making activity (i.e., law practice, farm or rental
properties). At the bottom of the chart, 3,715 miles were
attributed to the “farm” for trips on April 22, June 13, July
28 and October 11. However, the only elaboration of the
business purpose of the trips was the term “crops,” which
appears next to the dates. Charles Reynolds’ testimony on
his farming activities also undermined his case, since the
Tax Court found it “vague, confusing, and evasive.” But
perhaps the most damaging detail was an admission by
Reynolds that no crops were grown on his farm during the
1993 tax year.
Expenses attributed to the rental properties suffered
similar problems. For the 1993 tax year, the Reynolds at-
tributed 3,646 miles and $995.30 in hotel bills to two trips
to Virginia, where they own rental property. Yet, the only
business explanation for this substantial deduction is the
elliptical phrase “cleaning, leasing.” The corroborating evi-
dence, in combination with Charles Reynolds’ testimony
on the nature of these trips, simply does not have the “high
degree of probative value” necessary to put it on a par with
“adequate records” documentation. § 1.274-5T(c)(1); see
also Masat v. Commissioner, 784 F.2d 573, 575 (5th Cir.
1986) (ruling that mere fact that taxpayer owns out-of-state
property does not satisfy his or her burden of proving that
16 No. 00-2966
the travel expenses were motivated by business rather
personal reasons).
Of the four corroborating summaries presented at trial,
the 1993 chart is the most comprehensive breakdown.
Unfortunately, it does not contain the type of specific de-
tail mandated by the Treasury Regulations; all of the travel
and car maintenance expenses are listed by month rath-
er than by specific trip. See § 1.274-5T(c)(3)(i) (in the
absence of contemporaneous written evidence, requiring
“specific information in detail” as to each element of a
§ 274(d) deduction). The listed figures are presumably the
sum of adding together the voluminous receipts, though
only “representative” receipts were included in the record.7
But as the Tax Court correctly observed, many of these
receipts are for automobile repairs having no apparent
relationship to any particular trip or business. Section
§ 274(d) requires the taxpayer to prove the amount, date,
time, place and business purpose of each claimed expense.
The existence of these elements simply cannot be discerned
in any of the Reynolds’ reconstructed summaries.
The automobile and travel expenses for the Reynolds’
farming activities (Schedule F) and rental properties
(Schedule E) clearly fail because of inadequate substantia-
tion. See 26 C.F.R. § 1.274-5T(c)(1) (stating that non-con-
temporaneous evidence “must have a high degree of proba-
tive value” to establish eligibility for deduction). Although
7
The government emphasizes the fact that the Reynolds’ “repre-
sentative” sample is both incomplete and arbitrary in what is does
and does not support, but additional receipts would not have
helped the Reynolds’ case. Rather, the testimony and corroborat-
ing summaries, which were presented at trial, were insufficient
to establish the required elements of § 274(d). See Dowell, 522
F.2d at 714 (holding that a “virtual blizzard of bills, chits and
other papers” does not satisfy the “expenditure by expenditure
determination” required by § 274(d)).
No. 00-2966 17
we believe that the auto and travel expenses attributed
to the law practice (Schedule C) share similar defects,
they also suffer the more fundamental problem of being
nondeductible commuting expenses.
According to Reynolds, the mileage attributed to his law
practice resulted from travel between his home and a title
company, where he handled several real estate closings
for his clients. In general, commuting expenses between
home and work are personal and therefore nondeductible.
See Commissioner v. Flowers, 326 U.S. 465, 473-74 (1946);
accord H B & R, Inc. v. United States, 229 F.3d 688, 690
(8th Cir. 2000) (“Flowers established the general rule that
an employee’s expenses in commuting from home to work
are personal, not deductible business expenses.”); 26 C.F.R.
§ 1.262-1(b)(5) (“The taxpayer’s costs of commuting to
his place of business or employment are personal expenses
and do not qualify as deductible expenses.”). However, if a
taxpayer maintains a home office as a principal place of
business, and periodically travels to other sites to meet with
clients or otherwise conduct their business, then these
traveling costs are deductible as a business expense. That
said, the taxpayer bears the burden of producing sufficient
evidence to show that his “principal place of business” is, in
fact, a home office. Browning v. Commissioner, 890 F.2d
1084, 1087 (9th Cir. 1989). Here, the Tax Court noted that
during the 1993 and 1994 tax years, Charles Reynolds
failed to claim a home office deduction. While failure to
claim the deduction alone does not settle the issue of the
traveling costs, the court also stated that Charles Reynolds
“offered no evidence and made no argument that his ‘prin-
cipal place of business’ was at his home.” Notwithstanding
conclusory assertions contained in the Reynolds’ brief, the
record, as we read it, wholly supports this assessment.
Therefore, we conclude that none of the Schedule C auto
and travel expenses are deductible.
18 No. 00-2966
D.
The final issue on appeal is whether the Tax Court erred
in upholding an accuracy-related penalty under 26 U.S.C.
§ 6662 for the negligent underpayment of income taxes. The
term “negligence” is defined by statute to include “any
failure to make a reasonable attempt to comply with the
provisions of this title.” § 6662(c). The 1993 implementing
regulation states:
The term negligence includes any failure to make a
reasonable attempt to comply with the provisions of the
internal revenue laws or to exercise ordinary and rea-
sonable care in the preparation of a tax return. “Negli-
gence” also includes any failure by the taxpayer to keep
adequate books and records or to substantiate items
properly.
26 C.F.R. § 1.662-3(b)(1) (1993). At the outset, we note that
a finding of negligence under § 6662 is a finding of fact that
we review for clear error. See Hayden v. Commissioner, 204
F.3d 772, 775 (7th Cir. 2000). In addition, determinations
of negligence by the Commissioner “are presumed to be
correct, and the taxpayer has the burden of proving that the
penalties are erroneous.” Id. (citing Welch v. Helvering, 290
U.S. 111, 115 (1933); Forseth v. Commissioner, 845 F.2d
746, 749 (7th Cir. 1988)).
The Reynolds attempt to rebut the presumption of cor-
rectness by claiming that they have satisfied the “good
faith” affirmative defense, which is also provided by statute.
The relevant provision states that no penalty shall be
imposed for underpayment of taxes if the taxpayer can
demonstrate “that there was a reasonable cause for such
portion and that the taxpayer acted in good faith with re-
spect to such portion.” 26 U.S.C. § 6664(c). The Treasury
Regulation that implements this statute further elaborates:
The determination of whether a taxpayer acted with
reasonable cause and in good faith is made on a case-
by-case basis, taking into account all pertinent facts
No. 00-2966 19
and circumstances. The most important factor is the
extent of the taxpayer’s effort to assess the taxpayer’s
proper tax liability. Circumstances that may indicate
reasonable cause and good faith include an honest
misunderstanding of fact or law that is reasonable in
light of the experience, knowledge and education of the
taxpayer.
26 C.F.R. § 1.6664-4(b)(1) (1993) (emphasis added). Here,
the “experience, knowledge and education” proviso is fatal
for Charles Reynolds, who is a licensed attorney, certified
public accountant and IRS audit supervisor.8
As evidence of good faith, the Reynolds argue that they
classified their 1993 and 1994 using the CCH Master Tax
Guide, which is a treatise containing annotations to rele-
vant statutes, regulations and case law. Assuming arguendo
that reliance on an established secondary source can be
the basis of a § 6664(c) good-faith defense, the Reynolds
fail to direct us to the specific passages of the CCH Master
Tax Guide upon which they reasonably relied.
The Reynolds next assert that their 1994 tax return was
prepared using a commercial software program called Turbo
Tax, which they claim is a “tax preparer” and is subject to
IRS penalties. See Rev. Rul. 85-187, 1985-2 C.B. 338 (stat-
ing that a firm “that furnishes a computerized tax return
preparation service to tax practitioners is an income tax
preparer when the program used goes beyond mere mechan-
ical assistance”). This argument, however, goes nowhere.
In order to demonstrate an “honest misunderstanding
of fact or law” under § 1.6664-4(b)(1), the Reynolds must
at least make the threshold showing that reliance on
Turbo Tax caused them to make substantive errors in their
8
During cross-examination at trial, Charles Reynolds stated that
he is a licensed CPA in the state of South Carolina. In addition,
Reynolds is now retired from the IRS.
20 No. 00-2966
tax preparation. Even then, the mere fact of reliance may
not be enough. See § 1.6664-4(b)(1) (1993) (“Reliance on
an information return or on the advice of a professional
(such as an appraiser, attorney or accountant) does not
necessarily demonstrate reasonable cause and good faith.”).
Finally, the Reynolds defend their failure to allocate their
automobile expenses to Schedules C, E and F as the “con-
sidered judgment of a tax professional who recognized that
absolutely NO tax impact flowed from the allocation itself.”
The gist of the Reynolds’ argument is that no tax conse-
quences flow from the apportionment of expenses between
the Schedules since they all constitute “above-the line”
deductions used to calculate adjusted gross income. Yet, the
fact that all the claimed deductions were above-the-line
obscures the more fundamental problem that a more precise
allocation was not made because the Reynolds’ business
records were not adequately organized and thorough. At
trial, Charles Reynolds stated that “[a] more rigorous ap-
plication of the allocation guidelines or the application of
the mileage guidelines between Schedules C, Schedules E
and Schedule F would have required a substantial amount
of work, okay, in terms of . . . tying the receipts back to
support the mileage in each of these items.” But without
making these allocations, the required elements of substan-
tiation under § 274(d) cannot be met. Because of his sub-
stantial education and experience in tax law and adminis-
tration, we must impute basic knowledge of the elements of
substantiation to Charles Reynolds. We therefore uphold
the § 6662(a) accuracy-related penalties in their entirety.9
9
The accuracy-related penalties are calculated in relation to
specific underpayments. However, with the exception of an unfo-
cused argument on auto and travel expenses, the Reynolds’s brief
did not make good-faith defense arguments directed at any
specific underpayment penalty. The fact that the Reynolds failed
(continued...)
No. 00-2966 21
III.
For the forgoing reasoning, the judgment of the Tax Court
is AFFIRMED.
A true Copy:
Teste:
________________________________
Clerk of the United States Court of
Appeals for the Seventh Circuit
9
(...continued)
to substantiate various travel expenses has no bearing on ac-
curacy-related penalties for an underpayment resulting from
other tax errors. For example, the Reynolds failed to make any
argument that a good-faith defense applied to Charles Reynolds’
legal defense fees, which were erroneously deducted during the
1993 and 1994 tax years. Without a reasoned analysis, we can-
not disturb the Commissioner’s negligence determination, which
is presumptively correct. See Hayden, 204 F.3d at 775.
USCA-97-C-006—7-18-02