T.C. Summary Opinion 2010-40



                        UNITED STATES TAX COURT



           LEOPOLD KOZIEJ AND MARIA KOZIEJ, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



        Docket No. 28871-08S.              Filed April 12, 2010.



     Leopold Koziej and Maria Koziej, pro sese.

     Michael T. Shelton, for respondent.



     DEAN, Special Trial Judge:     This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect when the petition was filed.    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 in effect for the years in
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issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

     Respondent determined the following deficiencies

in, and accuracy-related penalties under section 6662(a) on,

petitioners’ Federal income taxes:

                                        Accuracy-Related Penalty
     Year        Deficiency                 Sec. 6662(a)

     2004          $2,559                      $511.80
     2005          10,120                     2,024.00

     The issues for decision are whether:      (1) Amounts deposited

in petitioners’ bank accounts in excess of their reported income

for 2004 and 2005 constitute income; and (2) petitioners are

liable for accuracy-related penalties under section 6662(a) for

2004 and 2005.

                              Background

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

The stipulation of facts, the stipulation of settled issues, and

the attached exhibits are incorporated herein by reference.        When

petitioners filed their petition, they resided in Illinois.

     Petitioners timely filed their 2004 and 2005 Federal income

tax returns.   They reported total gross sales of $429,866 for

2004 and $641,917 for 2005 from their construction business.

     During the years at issue petitioners operated JMB

Construction and borrowed money to cover expenses associated with

the costs of their business.
                                - 3 -

      In a notice of deficiency respondent determined that

petitioners failed to report income of $10,355 for 2004 and

$37,391 for 2005.   Respondent further determined that petitioners

were liable for accuracy-related penalties of $511.80 and $2,024

for 2004 and 2005, respectively.

      Petitioners agree that the disputed amounts were deposited

in their bank accounts and not reported as income for 2004 and

2005.   Petitioners assert, however, that these deposits

constituted loans and are thus nontaxable.

                             Discussion

I.   Evidentiary Matters

      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)

carves out an exception for trials of small tax cases under the

provisions of section 7463(a).     Under Rule 174(b), 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).

      Respondent objects to several documents proffered by

petitioners, arguing that they constitute inadmissible hearsay.
                                   - 4 -

      A.    Affidavits

      Petitioners proffered several affidavits from friends and

acquaintances averring that they had lent petitioners money in

2004 and 2005.

      There is no corroborating evidence, however, other than

petitioners’ own testimony, that petitioners’ friends lent them

money in 2004 or 2005.     For example, there is no evidence in the

record that petitioners entered into a loan agreement with any of

these parties or that petitioners intended to repay the “lent”

funds.     Therefore, the Court will sustain respondent’s

objections.     See Rule 174(b).

      B.    Checks

      Petitioners proffered several checks made out to “JMB

Construction” or “cash” and alleged that these checks constituted

loans.     Again, however, other than petitioners’ own testimony,

there is no evidence that the checks constituted loans as opposed

to income.

      Because there is no indication that these checks constituted

loans, sufficient grounds exist to sustain respondent’s

evidentiary objection.

II.   Burden of Proof

      Generally, the Commissioner’s determinations are presumed

correct, and the taxpayer bears the burden of proving that those
                                   - 5 -

determinations are erroneous.1      Rule 142(a); see INDOPCO, Inc. v.

Commissioner, 

, 84 (1992); Welch v. Helvering, 

, 115 (1933).

III.       Unreported Income

       Respondent determined deficiencies in petitioners’ Federal

income taxes for 2004 and 2005 by using the bank deposits method.

“The bank deposits method assumes that all money deposited

in a taxpayer’s bank account during a given period constitutes

taxable income, but the Government must take into account any

nontaxable source or deductible expense of which it has

knowledge.”       Clayton v. Commissioner, 

, 645-646

(1994).

       “The use of the bank deposit method for computing income has

long been sanctioned by the courts.”       Estate of Mason v.

Commissioner, 

, 656 (1975) (and cases cited thereat),

affd. 

(6th Cir. 1977).      “A bank deposit is prima facie

evidence of income and respondent need not prove a likely source

of that income.”       Tokarski v. Commissioner, 

, 77 (1986)

(citing Estate of Mason v. Commissioner, supra at 656-657).        The

burden of showing duplications is on the taxpayer.       Zarnow v.

Commissioner, 

, 216 (1967).



       1
      Petitioners have not claimed or shown that they meet the
requirements under sec. 7491(a) to shift the burden of proof to
respondent as to any factual issue relating to their liability
for tax.
                               - 6 -

     Petitioners reported gross sales of $429,866 for 2004.

That year deposits in their bank accounts totaled $495,406.43

Respondent determined that $10,355 of their unreported deposits

was income.   For 2005 petitioners reported gross sales of

$641,917.   Respondent calculated petitioners’ total deposits for

2005 and determined that $37,391 of the unreported deposits was

income.2

     Petitioners do not contest that unreported amounts of

$10,355 in 2004 and $37,391 in 2005, as determined by respondent,

were deposited into their bank accounts.    Petitioners assert,

however, that these amounts constituted loans and are thus

nontaxable.

     Receipt of a loan is not income to the borrower for Federal

income tax purposes.   Karns Prime & Fancy Food, Ltd. v.

Commissioner, 

, 405 (3d Cir. 2007), affg. T.C. Memo.

2005-233; Toberman v. Commissioner, 

, 988 (8th Cir.

2002), affg. in part and revg. in part T.C. Memo. 2000-221.    In

determining whether a given transaction constitutes a loan for

Federal income tax purposes, the substance, rather than the form,

of the transaction is controlling.     Karns Prime & Fancy Food,

Ltd. v. Commissioner, supra at 408.    The factors considered by

the courts to determine whether a transaction constitutes a valid



     2
      For 2005 respondent determined that $206,860.98 of
petitioners’ unreported deposits was not income.
                                - 7 -

debt include:   The existence of a written or formal debt

instrument, the existence of specific terms for the debt, the

terms for repayment of the debt, whether the taxpayer had any

legal obligation to repay the loan, and whether the taxpayer held

an actual intent to repay the loan.     Welch v. Commissioner, 

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

     Petitioners testified that they received several loans from

friends in 2004 and 2005 to finance their construction business.3

On September 21, 2005, they also obtained two lines of credit

totaling $303,060.

     Although petitioners testified that they received loans from

friends, there is no corroborating evidence showing that the

money they received constituted loans as opposed to income.

Petitioners did not present evidence that they entered into loan

agreements with any of their friends or that petitioners intended

to repay the purported loans.

     Petitioners provided multiple bank statements striving to

corroborate their testimony that they received loans from friends

in 2004 and 2005.    Petitioners identified several deposits,

claiming that the deposits constituted loans.    The bank

statements, however, are uninformative.    The statements designate


     3
      Marian Czarnik also testified that he lent petitioners
$4,000 in 2004. He verified that he endorsed a check written in
October 2004 for $4,000. This check, however, was made out to
“cash”, and there is no corroborating evidence that the money was
“lent” to petitioners.
                                 - 8 -

deposits simply as a “deposit” and provide the date and the

amount of the deposit.    The statements do not indicate the source

or origination of any of the deposited funds, and there is no

indication that the deposits constituted loans as opposed to

income.

      Petitioners also claim that they made several draws on their

line of credit in 2005.   Petitioners identified two separate

deposits in their bank records, on August 3 and 9, 2005.   They

argue that these deposits resulted from draws on their line of

credit; one in the amount of $40,000 and the other in the amount

of $80,000.   Despite petitioners’ assertions, these deposits were

actually made more than 1 month before the date petitioners

obtained their credit line.   Furthermore, petitioners did not

show that any remaining deposit in 2005 resulted from a draw on

their line of credit.

      Petitioners have failed to show that the unreported amounts

for 2004 and 2005 were attributable to loans or that they did not

constitute income.   On the basis of the foregoing, the Court is

unable to conclude that the unreported income is nontaxable.

Respondent’s determinations are sustained.

IV.   Accuracy-Related Penalty

      Section 6662(a) and (b)(1) and (2) imposes a 20-percent

accuracy-related penalty for any portion of an underpayment that
                                 - 9 -

is attributable to:   (1) Negligence or disregard of rules or

regulations; or (2) a substantial understatement of income tax.4

     Section 6662(c) defines “negligence” to include “any failure

to make a reasonable attempt to comply with the provisions of

this title,” and “disregard” to include “any careless, reckless,

or intentional disregard.”   Negligence also includes any failure

by the taxpayer to keep adequate books and records or to

substantiate items properly.   Sec. 1.6662-3(b)(1), Income Tax

Regs.

     The Commissioner bears the burden of production with respect

to the applicability of an accuracy-related penalty determined in

a notice of deficiency.   See sec. 7491(c).   In order to meet the

burden of production under section 7491(c), the Commissioner need

only make a prima facie case that imposition of the penalty or

addition to tax is appropriate.     Higbee v. Commissioner, 

, 446 (2001).   Once he has met his burden, the burden of proof

is upon the taxpayer to prove that the accuracy-related penalty

does not apply because of reasonable cause, substantial

authority, or the like.   See secs. 6662(d)(2)(B), 6664(c); Higbee

v. Commissioner, supra at 448.




     4
      Because the Court finds that petitioners were negligent or
disregarded rules or regulations, the Court need not discuss
whether there is a substantial understatement of income tax. See
sec. 6662(b).
                               - 10 -

     Respondent determined accuracy-related penalties of $511.80

and $2,024 for 2004 and 2005, respectively.     Petitioners’ tax

liabilities for 2004 and 2005 are attributable solely to their

failure to report as income their claimed receipt of loans.

Petitioners did not keep the records required by the Code to

substantiate receipt of loans.    Failure to keep adequate records

is evidence not only of negligence, but also of intentional

disregard of regulations.    See sec. 1.6662-3(b)(1) and (2),

Income Tax Regs.; see also Magnon v. Commissioner, 

,

1008 (1980).   Petitioners have failed to demonstrate that they

were not negligent, and the Court finds that respondent has met

his burden of production under section 7491(c).

     An accuracy-related penalty is not imposed on any portion of

the underpayment as to which the taxpayer acted with reasonable

cause and in good faith.    Sec. 6664(c)(1).   Section 1.6664-

4(b)(1), Income Tax Regs., incorporates a facts and circumstances

test to determine whether the taxpayer acted with reasonable

cause and in good faith.    The most important factor is the extent

of the taxpayer’s effort to assess his proper tax liability.

present any evidence or argument as to

why they should not be subject to the accuracy-related penalties
                              - 11 -

for 2004 and 2005.   Accordingly, respondent’s determinations of

accuracy-related penalties for 2004 and 2005 are sustained.

     To reflect the foregoing,


                                       Decision will be entered

                                 for respondent.