Yohannes Teka Lakew & Seble Bete v. Commissioner

T.C. Summary Opinion 2020-27
UNITED STATES TAX COURT
YOHANNES TEKA LAKEW AND SEBLE BETE, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 1854-18S. Filed November 4, 2020.
Yohannes Teka Lakew and Seble Bete, pro sese.
Jacob Russin, for respondent.
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SUMMARY OPINION1
GREAVES, Judge: This case was heard pursuant to the provisions of
section 74632 of the Internal Revenue Code in effect when the petition was filed.
Pursuant to section 7463(b), the decision to be entered is not reviewable by any
other court, and this opinion shall not be treated as precedent for any other case.
Respondent determined for petitioners’ 2015 taxable year a deficiency of
$9,005 and a section 6662(a) accuracy-related penalty of $1,801.
After respondent’s concession,3 the issues for decision are whether
petitioners are (1) entitled to offset gross receipts by unreported cash refunds and
(2) liable for a section 6662(a) accuracy-related penalty. We resolve both issues in
respondent’s favor.
1
This case was tried before Judge Robert P. Ruwe on December 4, 2019.
The Court issued an order proposing to reassign this case to another judicial
officer for purposes of preparing the opinion and entering the decision based on
the record of trial, or, alternatively, allowing the parties to request a new trial. The
parties did not object to the reassignment of the case. By order dated August 31,
2020, this case was submitted to Judge Travis A. Greaves.
2
Unless otherwise indicated, all section references are to the Internal
Revenue Code in effect at all relevant times, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
3
Respondent conceded after trial that petitioners are not subject to a $470
tax on qualified plans, including individual retirement accounts, and other tax
favored accounts, for 2015 as originally determined in the notice of deficiency.
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Background
The parties filed a stipulation of facts that is incorporated by this reference.
Petitioners resided in Maryland when they petitioned this Court.
Yohannes Lakew owned and operated a driving school in 2015, the year in
issue. Mr. Lakew’s customers made appointments and payments through a
computerized system operated by a third-party contractor, Stripe, Inc. (Stripe).4
During the year in issue some of Mr. Lakew’s customers were dissatisfied with his
service, and, to an extent we cannot quantify, he made cash refunds to them
outside of Stripe’s payment system. Stripe issued a 2015 Form 1099-K, Payment
Card and Third Party Network Transactions, to Mr. Lakew that reported payments
totaling $29,295; however, petitioners first saw the Form 1099-K after filing the
petition in this case.
Petitioners electronically filed a joint 2015 Form 1040, U.S. Individual
Income Tax Return. Petitioners included with the Form 1040 a Schedule C, Profit
or Loss From Business, reporting income and expenses from Mr. Lakew’s driving
school. On the Schedule C petitioners reported gross income of $7,290 and total
4
Mr. Lakew also used another appointment scheduling company.
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expenses of $11,447. This produced a reported loss of $4,157. Petitioners did not
report any returns or allowances.5
The IRS automated underreporter (AUR) program flagged petitioners’
return because of a mismatch between the reported income and the amounts on the
Form 1099-K that Stripe supplied to the IRS. On August 14, 2017, the AUR
program sent petitioners a Notice CP2000 indicating that they (1) owed $9,005 in
tax and (2) were liable for an accuracy-related penalty. The letter instructed
petitioners to file a response by September 13, 2017, if they did not agree with the
proposed adjustments.
Petitioners did not respond to the Notice CP2000. Consequently, the AUR
program automatically issued petitioners a notice of deficiency on November 6,
2017, wherein respondent determined the adjustments previously proposed.
Thereafter, petitioners petitioned this Court for redetermination of the deficiency
and the penalty. Petitioners do not dispute that Mr. Lakew received the money
reported on the Form 1099-K but contend that the driving school’s gross receipts
should be reduced by unreported cash refunds that Mr. Lakew paid to customers.
5
Taxpayers are instructed to report any cash or credit refund given to a
customer on Part I, line 2, “Returns and allowances”, of the Schedule C. 2015
Instructions for Schedule C, at C-5. Pursuant to Part I, line 3 of the Schedule C,
the amount reported on line 2 offsets the amount reported on line 1, “Gross
receipts or sales”.
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Discussion
I. Burden of Proof
The IRS’ determinations set forth in a notice of deficiency are generally
presumed correct, and the taxpayer bears the burden of proving that the
determination is in error. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115
(1933). Petitioners do not contend, and the evidence does not establish, that the
burden of proof shifts to respondent under section 7491(a) as to any issue of fact.
II. Unreported Cash Refunds
The principal issue is whether petitioners may offset the gross receipts from
Mr. Lakew’s driving school by unreported cash refunds he paid to his customers.
Gross income includes all income from whatever source derived. Sec. 61(a).
However, taxpayers with business income are allowed to offset the gross receipts
of their business with returns and allowances when computing the business’ gross
income. See Pittsburgh Milk Co. v. Commissioner, 26 T.C. 707, 717 (1956);
Smith v. Commissioner, T.C. Memo. 2015-214, at *11. Taxpayers must also
retain sufficient records to substantiate the amount of returns and allowances
reported “so long as the contents thereof may become material in the
administration of any internal revenue law.” Sec. 6001; sec. 1.6001-1(a), (e),
Income Tax Regs. With a general three-year assessment period (six years in the
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case of a substantial omission of income) from the time a return is filed, a taxpayer
has a duty to keep such records for no less than three years after the time such
return is filed. See sec. 6501(a), (e). In satisfying this recordkeeping duty, a
taxpayer’s self-serving declaration is generally not sufficient. Smith v.
Commissioner, at *11 (citing Weiss v. Commissioner, T.C. Memo. 1999-17).
Although Mr. Lakew issued cash refunds in connection with his driving
school business, petitioners provided us with very little, if anything, in the way of
credible evidence upon which to make a rational finding or estimate of the
amounts of those refunds. Mr. Lakew could not produce any receipts, bank
account statements, or other financial records of any kind relating to the business
to support his claimed refunds, even though he remained under a clear obligation
to do so. The only record of the refunds that Mr. Lakew introduced into evidence
was a single document entitled Istar Driving School: Annual Summary Income
Tracking Sheet (tracking sheet). This vague and uncorroborated tracking sheet,
together with Mr. Lakew’s testimony, are not, however, “sufficient records”. The
tracking sheet does not indicate what year it relates to, and petitioners did not
testify as to when it was prepared. Mr. Lakew testified that he found the tracking
sheet only a few days before trial. None of the figures provided in the tracking
sheet can be tied to either petitioners’ return or the Form 1099-K. The tracking
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sheet cannot be credibly cross-checked against any other document or information
with respect to even a single transaction in the 2015 tax year relating to Mr.
Lakew’s business, including such pertinent information as payor, payee, date, and
amount for any of the claimed refunds. Mr. Lakew also introduced Yelp reviews,
including one from a customer dated December 17, 2015, which stated that Mr.
Lakew “said that he was going to refund the money and we are still waiting for
this”. The Yelp reviews offer little support that Mr. Lakew actually issued all of
the claimed refunds. We therefore conclude that petitioners failed to satisfy their
burden, and we sustain respondent’s redetermination.
III. Accuracy-Related Penalty
Section 6662 imposes a 20% penalty on an underpayment of tax which is
attributable to a substantial understatement of income tax. Sec. 6662(a) and
(b)(2). An understatement of income tax is “substantial” if it exceeds the greater
of $5,000 or 10% of the tax required to be shown on the return. Sec.
6662(d)(1)(A).
Section 7491(c) generally provides that “the Secretary shall have the burden
of production in any court proceeding with respect to the liability of any individual
for any penalty”. This burden requires the Commissioner to come forward with
sufficient evidence indicating that imposition of the penalty is appropriate. See
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Higbee v. Commissioner, 116 T.C. 438, 446 (2001). The Commissioner’s burden
of production under section 7491(c) also includes establishing compliance with
section 6751(b)(1). See Graev v. Commissioner, 149 T.C. 485, 493 (2017),
supplementing and overruling in part 147 T.C. 460 (2016). Section 6751(b)(1)
requires personal, written supervisory approval of the “initial determination” of a
penalty assessment, unless the penalty is an addition to tax under section 6651,
6654, or 6655 or is “any other penalty automatically calculated through electronic
means.” See sec. 6751(b). Therefore the Commissioner is considered to satisfy
the burden of production if he shows an understatement of income tax to be
“substantial” and, when applicable, receives timely supervisory approval of the
initial determination of a penalty assessment.
The deficiency in petitioners’ 2015 income tax, which we have sustained
except to the extent conceded by respondent, reflects an underpayment attributable
to an understatement that exceeds the greater of $5,000 or 10% of the total tax
required to be shown on petitioners’ 2015 tax return.6 In addition no IRS
employee was involved in the issuance or review of either the CP2000 letter or the
notice of deficiency that contained the accuracy-related penalty as automatically
6
Respondent’s concession regarding the tax on qualified plans does not
change this result.
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generated by electronic means through the AUR program. Accordingly, no
supervisory approval was required in this case and respondent carried his burden
of production by demonstrating a “substantial” understatement of income tax.
The section 6662(a) penalty does not apply to any portion of an
underpayment “if it is shown that there was a reasonable cause for such portion
and that the taxpayer acted in good faith” with respect to it. Sec. 6664(c)(1). The
taxpayer bears the burden of proving reasonable cause and good faith. Higbee v.
Commissioner, 116 T.C. 446-448. Petitioners offered little argument or
evidence to establish that there was reasonable cause for the underpayment.
Petitioners substituted as gross receipts a figure that was one-fourth the amount
reported on the Form 1099-K, and for which they did not provide any credible
substantiation or reasonable explanation on their 2015 return. We therefore
sustain respondent’s imposition of the accuracy-related penalty under section
6662(a).
To reflect the foregoing,
Decision will be entered under
Rule 155.