T.C. Summary Opinion 2009-12



                      UNITED STATES TAX COURT



                  ANTOINE HABER, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 11032-06S.             Filed January 22, 2009.



     Antoine Haber, pro se.

     Carolyn A. Schenck, for respondent.



     GOLDBERG, Special Trial Judge:   This case was heard pursuant

to the provisions of section 7463 of the Internal Revenue Code in

effect at the time 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.   Unless otherwise indicated, subsequent

section references are to the Internal Revenue Code (Code) in
                                - 2 -

effect for the year in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure.

     This case centers on the explanation of bank deposits that

respondent determined to be unreported business income for 2003,

and on the substantiation of business expense deductions.     The

record is voluminous; therefore, we provide an initial factual

introduction to summarize the events leading up to the

commencement of this case.    Then in the background section, we

summarize the events that evolved into the issues for decision.

                             Introduction

     Some of the facts have been stipulated and are so found.

The stipulation of facts, the supplemental stipulations of facts,

and the attached exhibits are incorporated herein by this

reference.    Petitioner resided in California when he filed his

petition.

     During 2003 petitioner operated two unincorporated

businesses:    A cabinetmaking business and a hair and beauty

salon.   He conducted the cabinetmaking business under the names

“Production 2000” and “Cabinet 2000” and the hair salon under the

name “Touche de Salon & Day Spa”.    Petitioner started the

cabinetmaking business sometime in the 1990s.    He purchased an

existing hair salon around October 2000 and sold it in October or

November 2003.    At the time of trial petitioner was no longer

working.
                               - 3 -

      Petitioner reported the income and expenses for the two

businesses on two separate Schedules C, Profit or Loss From

Business, using the cash basis of accounting for both.    For the

cabinetmaking business he reported a loss of $11,732 on sales of

$156,480, and for the hair salon he reported a profit of $9,417

on sales of $351,060.1   Petitioner also recognized a capital gain

of $76,465 when he sold the hair salon for $89,157.

     In 2005 the IRS selected petitioner’s 2003 income tax return

for examination.   Using the bank deposits method of determining

income, the examiner found $128,595 in unexplained deposits in

the Production 2000 bank account, which the IRS determined was

unreported income.   To arrive at that amount the examiner added

up the deposits for the year, subtracted non-Schedule C deposits

such as the proceeds from the sale of the hair salon, and then

subtracted the taxable sales that petitioner had reported on

Schedule C.   In a similar manner, the examiner determined $3,014

in unreported income for the hair salon.

     Regarding expenses for the cabinetmaking business, the

examiner allowed an additional deduction of $9,099 for cost of

goods sold material purchases and $41,982 in additional

allowances for “Other expenses” summarized on line 27 of Schedule

C.   Pertaining to hair salon expenses, the examiner allowed an



      1
      The Court rounded the amounts in this opinion to the
nearest dollar.
                                - 4 -

additional deduction of $4,782 for advertising and $2,499 for

cost of goods sold.    The examiner disallowed $21,595 in “Other

expenses” summarized on line 27 of Schedule C.

     The combination of the above adjustments also caused

mathematical changes to petitioner’s self-employment tax and

itemized deductions.    The IRS issued a notice of deficiency dated

March 27, 2006, determining a $35,485 increase to income tax and

a $7,097 accuracy-related penalty.      In June 2006 petitioner

timely filed a petition with the Court, claiming that the IRS did

not allow him sufficient time to explain the deposits and to

prove his expenses.

            Background Leading to Issues for Decision

     In 2007 in preparation for trial respondent served on

petitioner’s bank a subpoena for the production of records,

through which respondent discovered a second bank account for the

cabinetmaking business in the name of Cabinet 2000.      Respondent

also discovered that petitioner did not have a personal bank

account and that he paid his personal expenses through his

business accounts.

     A week before trial the parties held their third pretrial

conference, where they agreed on a stipulation of facts.

Respondent reduced the additions to income, including conceding

the entire $3,014 of additional income for the hair salon,

because of interaccount transfers and other nontaxable deposits.
                                - 5 -

However, respondent’s analysis of the Cabinet 2000 bank account

determined additional unreported income such that petitioner had

a total of $142,912 in unexplained deposits for the cabinetmaking

business.

     At calendar call petitioner presented respondent with

additional documents, seeking to substantiate that almost all of

the $142,912 was not income and to substantiate deductions in

greater amounts than he had claimed on the Schedules C.

     The Court commenced the trial on October 17, 2007, in Los

Angeles.    Petitioner and two other individuals testified on

behalf of petitioner; namely, his tax return preparer and an

enrolled agent.    The IRS examiner testified for respondent.

Respondent objected to the lateness and content of petitioner’s

new evidence, and to the testimony of the enrolled agent on

grounds of authenticity, hearsay, and lack of foundation.

Regarding the enrolled agent, respondent objected specifically

that the agent did not participate in preparation of petitioner’s

return and that petitioner was offering the agent as an “expert”

witness.

     After completing the testimony regarding the adjustments

determined in the notice of deficiency, the Court reserved

judgment on respondent’s objections, adjourned the proceedings,

continued the case for further trial, and instructed the parties
                                 - 6 -

to meet to review petitioner’s new evidence and file a

supplemental stipulation of facts.

     About a week after the adjournment, after taking into

account the income adjustments discussed above, respondent filed

an answer in which he asserted a revised deficiency of $39,068,

and a revised accuracy-related penalty of $7,814.   During the

next few weeks, the parties met and respondent drafted a

supplemental stipulation of facts, where they settled many of the

disallowed deductions.   However, they continued to disagree on

the taxability of the $142,912 in unexplained deposits, and they

continued to disagree on many of the new deduction amounts.      On

November 29, 2007, in Washington, D.C., petitioner signed the

supplemental stipulation of facts, the parties completed

testimony and cross-examination regarding the new deductions, and

the Court concluded the trial.

     After all the concessions, the issues for decision are:     (1)

A ruling on respondent’s objections, (2) whether petitioner had

unreported taxable receipts, (3) whether petitioner is entitled

to deductions for the business expenses that remain in dispute,

and (4) whether petitioner is liable for the accuracy-related

penalty.

                            Discussion

     In general, the Commissioner’s determination set forth in a

notice of deficiency is presumed correct, and the taxpayer bears
                               - 7 -

the burden of showing that the determination is in error.     Rule

142(a)(1); Welch v. Helvering, 

, 115 (1933).     Under

section 7491(a), the burden may shift to the Commissioner

regarding a factual issue if the taxpayer produces credible

evidence and meets the other requirements of the section,

including maintaining records required by the Internal Revenue

Code and cooperating fully with the Secretary’s reasonable

requests for witnesses, information, documents, meetings, and

interviews.   Petitioner did not fulfill the requirements of

section 7491(a), and therefore the burden of proof regarding the

additional business deductions remains on petitioner.   With

respect to the increased deficiency that respondent asserted, the

burden of proof is on respondent.   Rule 142(a)(1); Shea v.

Commissioner, 

, 190-191 (1999); Wayne Bolt & Nut Co.

v. Commissioner, 

, 507 (1989).   Regarding penalties

and additions to tax section 7491(c) places the burden of

production on respondent.

I.   Ruling on Respondent’s Evidentiary Objections

      In general, the Court conducts trials in accordance with the

rules of evidence for trials without a jury in the U.S. District

Court for the District of Columbia and accordingly follows the

Federal Rules of Evidence.   Sec. 7453; Rule 143(a); Clough v.

Commissioner, 

, 188 (2002).   However, Rule 174(b) and

section 7453 carve out an exception for trials of small tax
                               - 8 -

cases.   Under this exception, the Court conducts small tax cases

as informally as possible and consequently may admit any evidence

that the Court deems to have probative value.   Schwartz v.

Commissioner, 

, 7 (2007).

      The copies of canceled checks and other documents that

petitioner offered as new evidence, as well as the testimony of

the enrolled agent, have probative value regarding petitioner’s

business income and deductions.   Therefore, sufficient grounds

exist to overrule respondent’s evidentiary objections.

II.   Unexplained Bank Deposits of Cabinetmaking Business--
      $142,912

      In cases of unreported income the Court of Appeals for the

Ninth Circuit, to which an appeal would ordinarily lie if this

case were appealable, requires that the Commissioner provide a

minimal evidentiary foundation connecting the taxpayer with the

unreported income before the presumption of correctness attaches

to the Commissioner’s determination.   See Hardy v. Commissioner,

, 1004 (9th Cir. 1999), affg. T.C. Memo. 1997-97;

Weimerskirch v. Commissioner, 

, 360-361 (9th Cir.

1979), revg. 

(1977); Petzoldt v. Commissioner, 

, 687-691 (1989).   Once the Commissioner has met this

initial burden, the taxpayer must establish by a preponderance of

the evidence that the Commissioner’s determination is arbitrary

or erroneous.   See Hardy v. 

at 1004.
                                - 9 -

     Section 6001 requires taxpayers to maintain books and

records adequate to determine their tax liability.    Where a

taxpayer fails to keep adequate records, section 446(b)

authorizes the Commissioner to reconstruct the taxpayer’s income

using a method that accurately determines the income.    Courts

have long sanctioned the Commissioner’s use of the bank deposits

method to reconstruct income.    Goe v. Commissioner, 

(3d Cir. 1952), affg. a Memorandum Opinion of this Court.      While

not conclusive, bank deposits are prima facie evidence of income.

Tokarski v. Commissioner, 

, 77 (1986); Estate of Mason

v. Commissioner, 

, 656 (1975), affd. 

(6th

Cir. 1977).    Ordinarily, after the Commissioner has determined

that unexplained deposits constitute income, the taxpayer has the

burden of proving such determinations are erroneous.    Rule

142(a); Welch v. Helvering, supra; Nicholas v. Commissioner, 

, 1064 (1978); Harper v. Commissioner, 

,

1129 (1970).   However, in this instance, with respect to the

unexplained deposits in the second bank account, because these

deposits are the basis for respondent’s assertion of an increased

deficiency, the burden of proof remains with respondent.       Shea v.

at 190-191; Wayne Bolt & Nut Co. v.

at 507.

     A loan is an agreement that is either express or implied,

where one person advances money to the other and the other agrees
                                - 10 -

to repay the advance with terms including the repayment period

and the interest rate.     Welch v. Commissioner, 

,

1230 (9th Cir. 2000), affg. T.C. Memo. 1998-121.     Because the

receipt of money pursuant to a loan is offset by a corresponding

obligation to repay, the proceeds of a loan are not includable in

income.   Commissioner v. Tufts, 

, 307 (1983).      For a

bona fide loan to exist the parties must have had an actual

intent to establish a debtor-creditor relationship at the time of

advancing the funds.     Estate of Chism v. Commissioner, 

, 960 (9th Cir. 1963), affg. Chism Ice Cream Co. v.

Commissioner, T.C. Memo. 1962-6; Fisher v. Commissioner, 

, 909-910 (1970).     The specific facts and circumstances

determine whether the parties intended to establish a

debtor-creditor relationship.     Estate of Chism v. 

at 960; Fisher v. 

at 910.

     The Court of Appeals for the Ninth Circuit considers seven

factors to determine whether a debtor-creditor relationship

existed, with no single factor being determinative.      Welch v.

at 1230.     The factors are:   (1) Whether a

note or other instrument evidenced the promise to repay; (2)

whether the lender charged interest; (3) whether the parties

established a fixed schedule for repayment; (4) whether the

borrower provided collateral to secure payment; (5) whether the

borrower made repayments; (6) whether the borrower had a
                               - 11 -

reasonable prospect of repaying the loan and whether the lender

had sufficient funds to advance the loan; and (7) whether the

parties conducted themselves as if the transaction was a loan.

     Petitioner contends that two nontaxable loans gave rise to

almost all of the unexplained deposits:    $69,000 from a line of

credit and $73,000 from a business colleague, for a total of

$142,000.   Below, we discuss petitioner’s contentions.

     A.   Line of Credit Borrowing of $69,000

     To substantiate the $69,000 borrowing, petitioner offered

into evidence his two-page “Account Transaction History”, dated

March 2, 2004, from his bank showing that a $100,000 line of

credit was available to petitioner from March 2000 at an interest

rate of 4.54 percent.    Pertinent here, the listing shows that

petitioner borrowed $69,000 on March 20, 2003.    Petitioner

provided no other documentation regarding the $69,000.    The

transaction history shows that on May 16, 2003, petitioner made

or received a principal reduction of $31,481 but otherwise shows

only minor repayments.

     Review of petitioner’s bank statements and individual

deposits establishes that petitioner did not deposit the $69,000

into the cabinetmaking business bank account during 2003.

Petitioner testified that he might have deposited the $69,000

into the bank account of US Hospitality Services, Inc.
                                - 12 -

(Hospitality, Inc.).     Therefore, the $69,000 could not have been

and was not part of the unexplained deposits.

       B.   Funds From a Business Colleague--$73,000

       In December 2003 petitioner deposited into the Production

2000 bank account two checks totaling $73,000 from Hospitality,

Inc.    Petitioner signed the first check, which was No. 103, for

$50,000, dated December 1, 2003, and payable to Production 2000.

Petitioner also signed the second check, which was No. 108, for

$23,000, dated December 11, 2003, and payable to himself.      The

address printed on the two Hospitality, Inc. checks is the same

address as petitioner’s cabinetmaking business location.

       Mike Chatham individually, or with his ex-wife, owned

Hospitality, Inc.     Petitioner met Mr. Chatham around 2001 or 2002

when Mr. Chatham was managing a renovation project at Century

Plaza Hotel.     Mr. Chatham started using a desk in petitioner’s

cabinetmaking business office in March 2003 to receive mail and

telephone messages and to fulfill other business needs.

Petitioner testified that when Mr. Chatham was away, he had Mr.

Chatham’s permission to access and sign Hospitality, Inc. checks.

       Petitioner and Mr. Chatham never drafted a formal loan

agreement.     Instead, they wrote a few words on a piece of paper

simply documenting petitioner’s receipt of $73,000.     Petitioner

lost the piece of paper.     To substantiate that the $73,000 was

bona fide indebtedness, petitioner relies mainly on his own
                              - 13 -

testimony and a notarized one-page declaration from Mr. Chatham,

together with an undated two-page exhibit listing purported

repayments.

     Courts have long established that we need not accept a

taxpayer’s testimony in the absence of corroborating evidence.

Geiger v. Commissioner, 

, 689-690 (9th Cir. 1971),

affg. per curiam T.C. Memo. 1969-159; Niedringhaus v.

Commissioner, 

, 212 (1992).    The declaration that Mr.

Chatham signed does not, without additional evidence, establish

the existence of a bona fide debt.     See Turner v. Commissioner,

, 654 (11th Cir. 1987), affg. T.C. Memo. 1985-159;

Cordes v. Commissioner, T.C. Memo. 1994-377.    The declaration

dated August 8, 2007, was not a contemporaneous document, did not

state that the $73,000 was a loan, did not mention an interest

rate, and did not discuss collateral.    Further, Mr. Chatham did

not provide his address or telephone number, petitioner did not

call Mr. Chatham as a witness, and petitioner did not comply with

respondent’s request for Mr. Chatham’s contact information.

Similarly, the exhibit attached to the declaration does not

indicate when or by whom or under what circumstances the listing

was prepared.   Petitioner acknowledged that some of the payments

were for his own business or personal expenses.    Moreover,

petitioner provided no canceled checks or other documentation

showing the purpose of the payments on the listing.
                               - 14 -

     Respondent sought to establish that Hospitality, Inc., was a

related party to petitioner.   Petitioner testified that he was

not affiliated with the business and he did not have any

ownership interest in Hospitality, Inc.   The Court received into

evidence from respondent a copy of the Cabinet 2000 Web site

homepage, which contained a hyperlink to “US Hospitality”.    When

respondent questioned petitioner about the link, petitioner

responded that he commissioned the Cabinet 2000 Web site in 2006

and the link was actually to US Hospitality, L.L.C., not to

Hospitality, Inc.   Presently, no Web site exists for Hospitality,

Inc., but a review of the Web site for US Hospitality, L.L.C.,

confirmed a relationship to petitioner’s Cabinet 2000 business.

     We find it particularly strange that petitioner signed the

two checks from another corporation’s bank account; namely,

Hospitality, Inc.   All of this suggests that petitioner was not

forthcoming about his relationship with Mr. Chatham or the

reasons for the transaction.

     In summary, through the bank deposits method analysis,

respondent   met his burden under Rule 142(a) for establishing an

increased deficiency, and respondent met his burden under the

standard set by the Court of Appeals for the Ninth Circuit for

determining whether a debtor-creditor relationship existed.

Petitioner, however, did not establish that his receipt of

$73,000 was bona fide indebtedness related to a debtor-creditor
                                - 15 -

relationship.    For all the foregoing reasons, we sustain

respondent’s determination that petitioner had $142,912 in

unreported taxable receipts in 2003.

III.   Business Expense Deductions Remaining in Dispute

       Deductions are a matter of legislative grace, and taxpayers

bear the burden of proving their entitlement to a deduction.

INDOPCO, Inc. v. Commissioner, 

, 84 (1992); New

Colonial Ice Co. v. Helvering, 

, 440 (1934).       Section

6001 requires taxpayers to maintain records sufficient to

establish the amount of each deduction.    See also sec. 1.6001-

1(a), (e), Income Tax Regs.    Taxpayers may deduct only the

business expenses that they can substantiate.    Ronnen v.

Commissioner, 

, 102 (1988).

       Cost of goods sold is an offset to gross receipts in

determining gross income.     Metra Chem Corp. v. Commissioner, 

(1987); Nunn v. Commissioner, T.C. Memo. 2002-250;

Wright v. Commissioner, T.C. Memo. 1993-27; sec. 1.61-3(a),

Income Tax Regs.    Thus, the Code does not treat costs of goods

sold as deductions from gross income, and they are not subject to

the limitations on deductions contained in sections 162 and 274.

See Metra Chem Corp. v. 

; B.C. Cook & Sons,

Inc. v. Commissioner, 

, 428 (1975), affd. per curiam

(5th Cir. 1978); Nunn v. 

; secs.

1.61-3(a), 1.162-1(a), 1.471-3, Income Tax Regs.    Nonetheless,
                                - 16 -

taxpayers must substantiate the amount they claim as cost of

goods sold, and they must maintain sufficient records for this

purpose.    Sec. 6001; Nunn v. 

; Wright v.

; sec. 1.6001-1(a), Income Tax Regs.

     A taxpayer may deduct ordinary and necessary expenses that

he or she pays in connection with the operation of a trade or

business.    Sec. 162(a); Boyd v. Commissioner, 

, 313

(2004).    To be “ordinary” the expense must be of a common or

frequent occurrence in the type of business involved.          Deputy v.

du Pont, 

, 495 (1940).       To be “necessary” an expense

must be “appropriate and helpful” to the taxpayer’s business.

Welch v. 

.       Additionally, the

expenditure must be “directly connected with or pertaining to the

taxpayer’s trade or business”.     Sec. 1.162-1(a), Income Tax Regs.

Section 262(a) disallows deductions for personal, living, or

family expenses.

     If a taxpayer establishes that an expense is deductible but

is unable to substantiate the precise amount, we may estimate the

amount, bearing heavily against the taxpayer whose inexactitude

is of his own making.     Cohan v. Commissioner, 

, 543-

544 (2d Cir. 1930).     The taxpayer must present sufficient

evidence for the Court to form an estimate because without such a

basis, any allowance would amount to unguided largesse.         Williams
                                  - 17 -

v. United States, 

, 560-561 (5th Cir. 1957); Vanicek

v. Commissioner, 

, 742-743 (1985).

     A.   Expenses for the Cabinetmaking Business

     We provide the table below to show the evolution of the

eight business expenses that remain in dispute pertaining to the

cabinetmaking business, and then we discuss the individual

expenses.

                                  Adjustment
                                      Per       Addtl.      Amount
Cabinetmaking         Amount on    Notice of    Amount     Remaining
  Business           Tax Return   Deficiency   Claimed    in Dispute

Cost of goods sold:
  Labor             $45,351             -0-     $2,700     $2,700
  Materials          43,731         +$9,099     16,473     16,473
Bank charges            -0-             -0-        224         224
Office supplies          883            -0-       165          165
Rent                 16,400             -0-     4,296       4,296
Property taxes        4,192             -0-       341          341
Telephone               888             -0-     1,195         666
Utilities                -0-            -0-     5,630      1,360

            1.   Cost of Goods Sold--Labor--$2,700

     Petitioner reported $45,351 in labor expenses on his

Schedule C, which the IRS allowed in full.     Petitioner now seeks

to deduct $2,700 in additional labor expenses, offering as

substantiation four canceled checks written to four separate

individuals and totaling $2,700.      Each check contains a notation

in the memo line:    Two checks have words that reference specific

work projects, and the other two checks have the notations “Help”

and “Help at work”.     One of the individuals also worked for
                              - 18 -

Hospitality, Inc.   Petitioner did not provide a Form W-2, Wage

and Tax Statement, reporting for any of the four individuals, and

he did not offer any Forms 1099-MISC, Miscellaneous Income, to

show that he reported these payments to the IRS.

     In petitioner’s business, commercial cabinetmaking, hiring

occasional project labor is ordinary and necessary.   Respondent

accepted in full the amount petitioner claimed on his tax return,

indicating accuracy, and the revelation of a second bank account

with additional business receipts and payments makes it credible

that petitioner would have additional labor expenses.   The

notations on the checks also indicate that the payments were for

work-related project labor.   The fact that one of the laborers

also worked for Hospitality, Inc., does not seem significant.

Hospitality, Inc., shared office space with petitioner’s

cabinetmaking business, and it is plausible they would use some

of the same laborers.

     Respondent made broad assertions that petitioner did not

distinguish his business versus personal expenses and that

petitioner did not provide accounting records to support the

labor expenses.   However, for these particular labor expenses

respondent did not refute petitioner’s specific evidence

regarding the canceled checks.   Therefore, petitioner is entitled

to $2,700 in additional labor expenses.
                               - 19 -

          2.   Cost of Goods Sold--Materials--$16,473

     On his Schedule C petitioner reported $43,731 in cost of

goods sold material purchases.    The IRS allowed the amount in

full plus an additional $9,099.    To support his request for an

additional amount, petitioner submitted 29 canceled checks

totaling $16,473.   These checks showed payees reflecting mostly

material purchases from businesses such as Calif. Panel & Veneer

Co., E.B. Bradley Co. (a wholesale distributor of woodworking

supplies), and Anderson Saw Co., Inc.    Two of the checks showed

that petitioner paid for subcontract labor and electrical work.

A third check for $52 had “USH” written as a notation, and

petitioner acknowledged that he had paid this amount on behalf of

Hospitality, Inc.   Otherwise, the check notations were blank,

referenced invoice numbers, or noted the names of work projects.

     Purchases of wood and hardware and payments to

subcontractors are ordinary and necessary expenses for a

commercial cabinetmaker.   The late discovery of the second bank

account makes additional expenses plausible.    The project- and

invoice-related notations on the memo lines of the checks add to

the credibility of the business purpose of the purchases.

     Respondent made general statements about petitioner’s

failure to produce accounting records and to segregate business

from personal expenses.    However, the record does not show that

petitioner was conducting a personal project or that the IRS
                                 - 20 -

examiner previously allowed these specific purchases in the

$9,099 of allowances in the notice of deficiency.   Therefore,

petitioner is entitled to $16,421 ($16,473 minus the $52 he paid

on behalf of Hospitality, Inc.) for his supplemental material

purchases.

          3.      Bank Charges--$224

     Petitioner did not claim a deduction for bank charges on his

tax return, but he now seeks a deduction of $224.   To

substantiate his claim, petitioner provided bank statements from

the Cabinet 2000 account that list monthly service charges and a

printing charge for new checks totaling $224.

     Bank charges are an ordinary and necessary business expense.

Respondent established that petitioner paid his personal expenses

through his business checking accounts.    Petitioner did not show

or even attempt to show the percentage of business use.   Because

the inexactitude is of petitioner’s own making, we rely on Cohan

v. 

, and attribute one-half of

the bank charges to petitioner’s personal use.   Accordingly,

petitioner may deduct $112, which is one-half of the $224 total

bank charges.

             4.   Office Supplies--$165

     On his tax return petitioner deducted $883 in office supply

expenses, which the IRS allowed in full.   Petitioner seeks to

deduct an additional $165 in office supplies by providing five
                                - 21 -

checks totaling $165.    The checks had payees such as the U.S.

post office, Sparkletts (bottled water), and Office Max.    One of

the checks, for $46, contained a notation in the memo line

indicating that it was for Cabinet 2000.

     While office supplies are an ordinary and necessary expense,

as noted above, petitioner paid for personal expenses through his

business accounts.    Other than the $46 check, petitioner has not

established the business use of the office supplies.    Under Cohan

v. Commissioner, 

(2d Cir. 1930), we estimate that

one-half of the remainder was for business use.    Consequently,

petitioner may deduct $105.50 as a supplemental deduction for

office supplies determined as follows:    $46 plus $59.50, the

latter figure equaling one-half of $165 minus $46.

          5.   Rent--$4,296

     Petitioner deducted rent expenses of $16,400 on his tax

return, which the IRS allowed in full.    As part of the additional

documents, petitioner presented three checks, each for $1,432,

totaling $4,296.     The checks were dated January 1, March 23, and

April 28, 2003, respectively, and were all payable to the

Metropolitan Transport Authority.    One check had no notation, and

the other two referenced invoice numbers.

     Rent is an ordinary and necessary expense.    Respondent did

not show that any of these three specific payments was part of

the $41,982 in additional “other” expenses that the IRS allowed
                                - 22 -

as a result of the audit.     On the basis of the three checks, we

conclude that petitioner’s base monthly rent was $1,432.     Because

petitioner continued in his cabinetmaking business location until

2006, it seems probable that the Metropolitan Transportation

Authority would have enforced petitioner’s monthly rent

obligation during 2003.    Because neither side produced evidence

to the contrary, we apply Cohan v. 

, to

conclude petitioner paid 12 months of rent at $1,432 per month,

which totals $17,184.     Since respondent has already allowed a

deduction of $16,400, petitioner may deduct the difference, $784

($17,184 minus $16,400) as an additional rent expense.

           6.   Property Taxes--$341

     Petitioner deducted $4,192 in property taxes on his tax

return, which the IRS allowed in full.     Petitioner seeks an

additional property tax deduction by providing two canceled

checks totaling $341.     Both checks were payable to the Los

Angeles County Tax Collector.     One check had no description on

the memo line, and the other referenced a bill number.

     Petitioner’s business and residence were both in Los Angeles

County.   Petitioner did not provide evidence that these two

payments were for his cabinetmaking business as opposed to his

residence.   As a result, petitioner may not deduct an additional

expense for property taxes.
                                 - 23 -

          7.   Telephone--$666

     Petitioner claimed $888 in telephone expenses on his return,

which the IRS allowed in full.     As part of the additional

documents, petitioner provided 15 checks totaling $1,195 and

payable to the following four different telephone carriers: AT&T,

Pacific Bell, SBC California, and Verizon.     Respondent allowed

$529 of these additional payments where the notation line

contained a reference to petitioner’s business telephone number.

Respondent did not allow the remaining $666 of expense because:

The telephone number on the memo line was not for petitioner’s

business; the payee was Verizon, which was the carrier for

petitioner’s home telephone line; or the memo line on the check

contained no notation, making it unclear whether the expense was

business or personal.   Section 262(b) disallows a deduction for

the first telephone line provided at a taxpayer’s residence.

     Thus, in sum respondent has allowed $1,417 ($888 plus $529)

in telephone expense deductions, or 68 percent of petitioner’s

total claim of $2,083 ($888 plus $1,195).     Regarding the

remaining $666, petitioner provided no substantiation showing

business use, and we find no grounds to decide a higher

percentage than respondent has already allowed.     For the

foregoing reasons, petitioner may not deduct any of the $666 in

telephone expenses that remain in dispute.
                               - 24 -

           8.   Utilities--$1,360

     Petitioner claimed no utility expense deduction on his tax

return.    However, in the additional documents petitioner provided

respondent with copies of canceled checks that totaled $5,630 for

water, sewer, and electric payments.     Respondent allowed all of

these payments, except for seven payments totaling $1,360, all

payable to the LA Department of Water and Power.

     Respondent disallowed these particular payments because

notations on the memo lines showed three different account

numbers.    Thus, some of the payments may have been for

petitioner’s residence.    Petitioner did not provide copies of the

bills or any other documentation substantiating the business

versus personal use.

     Because petitioner made payments on two accounts in March,

April, and May, and because of petitioner’s lack of

documentation, we apply Cohan v. 

, to conclude

that petitioner may deduct $680, which is one-half of the $1,360

in utility expenses remaining in dispute.

     B.    Expenses for the Hair Salon

     Below is a table that details the evolution of the four

expenses that remain in dispute pertaining to the hair salon.

Below the table we discuss each of the expenses.
                                - 25 -

                                  Adjustment
                                      Per       Addtl.        Amount
                    Amount on      Notice of    Amount       Remaining
  Hair Salon       Tax Return     Deficiency   Claimed      in Dispute

  Bank charges      $5,513         ($5,369)      $280        $5,649
  Maintenance        3,225          (3,225)     3,035           190
  Rent               3,875          (3,875)    17,737        21,612
  Property taxes     4,375          (4,375)       206         4,581

          1.   Bank Charges--$5,649

     Petitioner deducted $5,513 in bank charge expense on his tax

return.   The IRS allowed $144.    Petitioner now seeks a revised

deduction of $5,793, which leaves $5,649 in dispute ($5,793 -

$144).

     To support his claim, petitioner provided copies of 11

months of bank statements (January through the beginning of

November; petitioner sold the business in October).       The

statements showed daily deposits of the hair salon’s cash and

credit card receipts.   The bank labeled the cash receipts simply

as deposits and the credit card receipts as “Mtot” (merchant

account total batch) deposits.     After each Mtot deposit the bank

recorded a corresponding bank charge also labeled Mtot, usually

about 1.51 percent of the credit card deposit amount.       The bank

statements also showed three other types of charges:       Mtot

discounts, settlement charges, and merchant fees.        Petitioner’s

enrolled agent testified that these types of charges were typical

of the fees that the various credit card companies charge.
                                - 26 -

Petitioner totaled all four types of bank charges to arrive at

$5,793.

     Bank charges are an ordinary and necessary expense.

Respondent disallowed the charges because petitioner did not

submit the underlying agreements with the credit card companies

or his bank and because some of the Mtot charges do not appear

linked to any particular credit card deposit.

     We find that the bank statements are sufficient

substantiation.   The reference numbers, dates, and types of

charges corresponded to the hair salon’s credit card use, noting

that different credit card companies charge varying amounts.

Therefore, on the basis of the foregoing, petitioner is entitled

to deduct an additional $5,649 for bank charges, which is the

$5,793 in total charges less the $144 that respondent has already

allowed.

           2.   Maintenance--$190

     Petitioner deducted $3,225 in maintenance expenses on

Schedule C, which the IRS disallowed entirely.     Petitioner

presented copies of canceled checks totaling $3,035, which

respondent allowed in full.     In a posttrial brief petitioner

conceded the remaining $190 ($3,225 - $3,035).

           3.   Rent--$21,612

     Petitioner deducted $3,875 in rent expenses on his tax

return.    The IRS disallowed the entire amount because petitioner
                               - 27 -

did not provide supporting documentation.   In the supplemental

stipulation of facts, petitioner stated that he was seeking a

$36,000 deduction on the basis of the monthly rent expense of

$3,000.   However, in additional documents, petitioner presented

copies of eight canceled checks totaling $21,612, which

petitioner now claims is the correct rent expense for the year.

     The payee on each of the eight checks was “Harry” or Gary

Hindoyan or was left blank, but the bank cashed the checks

anyway.   Petitioner stated that Harry was the brother of the

landlord, Gary Hindoyan, and was a coowner of the property.      All

eight checks cleared through the identical bank account number

and all the checks were for $3,000, except for one check which

was for $612.    Petitioner stated that the $612 check was a

prorated amount because he sold the salon during the year and was

vacating the premises.

     To further support his rent expense, petitioner provided a

one-paragraph notarized declaration dated October 14, 2007, from

Gary Hindoyan.   The declaration, which included at the top Mr.

Hindoyan’s address and telephone number, stated that petitioner

was his tenant and that petitioner paid $3,000 as monthly rent

during the duration of his occupancy, from October 2000 to

October 2003.

     Rent is an ordinary and necessary expense.   Respondent’s

primary argument is that petitioner did not adequately
                               - 28 -

substantiate the rent expense because:      Petitioner provided only

canceled checks, i.e., no lease agreement; the checks have

varying payees and some have no payees; and petitioner did not

call the landlord as a witness.

     We find that petitioner adequately explained the payees,

especially where all the checks cleared through the same bank

account.   Further, the landlord’s declaration, unlike Mr.

Chatham’s discussed above, provide contact information.

Moreover, the landlord’s name appears on the property tax bills

discussed below.   We conclude that petitioner’s substantiation

was sufficient, and therefore petitioner may deduct $21,612 in

rent expense.

           4.   Property Taxes--$4,581

     Petitioner deducted $4,375 in property taxes on his tax

return, which the IRS disallowed entirely because petitioner did

not provide supporting documentation.      Petitioner presents three

canceled checks totaling $4,581, which he claims is his correct

property tax expense for the year.      The first two checks were

each for $2,181:   One was payable to Gary Hindoyan, and the other

had no payee.   Both checks cleared through the identical bank

account, the same one as the rent checks.      The third check was

payable to the Los Angeles Tax Collector for $219.      Petitioner

and the enrolled agent testified that the $219 payment was for

personal property taxes on equipment in the hair salon.
                                 - 29 -

      To further support his claim, petitioner provided a copy of

a contemporaneous tax bill, addressed to his landlord care of the

Hindoyan Trust, at 535 South Lake Avenue, for property at the

address 546 South Lake Avenue.     The bill showed two installment

payments due for $6,813 each.     Petitioner explained that the

building contained three businesses, his was in the middle, and

the landlord prorated the tax bill among the three tenants on the

basis of the square footage.

      Respondent denied the deduction because: petitioner did not

provide a copy of the lease agreement; petitioner’s residence was

in Los Angeles County; and the address on the bill was slightly

different from the address of petitioner’s hair salon, which was

548 South Lake Avenue.

      Petitioner has adequately substantiated the property tax

expense.   The following evidence was particularly persuasive:

The property tax bill to Mr. Hindoyan; petitioner’s testimony

regarding the triple net lease, the layout of the building, and

the proration of the taxes; and petitioner’s and the enrolled

agent’s testimony regarding the personal property tax bill.       For

the foregoing reasons, petitioner may deduct property taxes of

$4,581.

IV.   Accuracy-Related Penalty

      Taxpayers may be liable for a 20-percent penalty on the

portion of an underpayment of tax attributable to negligence or
                                - 30 -

disregard of rules or regulations or to a substantial

understatement of income tax.    Sec. 6662(a) and (b)(1) and (2).

     Negligence is a failure to make a reasonable attempt to

comply with the provisions of the Code.    The taxpayer is required

to prove he acted with due care.    Sec. 6662(c); Collins v.

Commissioner, 

, 1386 (9th Cir. 1988), affg. Dister

v. Commissioner, T.C. Memo. 1987-217; sec. 1.6662-3(b)(1), Income

Tax Regs.   Negligence penalties do not apply where the taxpayer

shows that he had reasonable cause and acted in good faith.     Sec.

6664(c)(1).   The determination depends on the facts and

circumstances of each case and includes the knowledge and

experience of the taxpayer and the reliance on the advice of a

professional, such as an accountant.     Sec. 1.6664-4(b)(1), Income

Tax Regs.   Most important in this determination is the extent of

the taxpayer’s effort to determine the proper tax liability.

of income tax occurs if the

amount of the understatement exceeds the greater of 10 percent of

the tax required to be shown in the return or $5,000.    Sec.

6662(d)(1)(A).   The amount of the understatement is reduced where

the taxpayer had substantial authority for the tax treatment, or

where the taxpayer adequately disclosed the relevant facts and

the taxpayer had a reasonable basis for the tax treatment.      (Sec.

6662(d)(2)(B).
                                - 31 -

     Respondent has met his burden of production by establishing

that petitioner maintained his books and records in a negligent

manner and that mathematically petitioner substantially

understated his income tax.    Petitioner asserts that the original

figures he supplied to his tax return preparer were wrong because

he had a new bookkeeper who made mistakes.     Petitioner also

alleges that he had forgotten about the Cabinet 2000 bank account

and that his recent divorce had diverted his attention.

     These reasons are not sufficient to establish reasonable

cause for inadequate recordkeeping.      See LeBouef v. Commissioner,

T.C. Memo. 2001-261.   We sustain respondent on the accuracy-

related penalty.

                              Conclusion

     To reflect our disposition of the issues,


                                             Decision will be entered

                                         under Rule 155.