T.C. Memo. 2020-84



                         UNITED STATES TAX COURT



                   RANDY G. SELLERS, Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 5742-18.                           Filed June 15, 2020.



      D. Loren Washburn, for petitioner.

      Randall Craig Schneider and Rebekah A. Myers, for respondent.



            MEMORANDUM FINDINGS OF FACT AND OPINION


      BUCH, Judge: For the years at issue, Mr. Sellers filed individual returns

and returns on behalf of his businesses. On his individual returns and on the

returns of one of his corporations, Mr. Sellers deducted nonpassive losses

attributed to two passthrough entities: King’s Dominion Investments, LLC (King’s

Dominion), and SS Marine, LLC.
                                         -2-

[*2] The Commissioner issued a notice of deficiency recharacterizing these

losses as passive and disallowing many of Mr. Seller’s deductions, including a

self-employed health insurance expense deduction. The Commissioner also

determined accuracy-related penalties under section 6662(a).1 After concessions,

the issues that remain are whether Mr. Sellers and his corporation had sufficient

bases in the passthrough entities to deduct their reported losses, whether Mr.

Sellers materially participated in SS Marine, and whether he may deduct his

self-employed health insurance expenses.

      Mr. Sellers’ losses were passive because he did not establish that he

materially participated in SS Marine. He also failed to substantiate his or his

corporation’s bases in his passthrough entities. Additionally, Mr. Sellers failed to

substantiate his expenses for the self-employed health insurance deduction.

                               FINDINGS OF FACT

      Randy Sellers is a certified public accountant who contracts with

Professional Business Advisors (PBA), an accounting firm in Salt Lake City, Utah.

Mr. Sellers has an office at PBA where he performs accounting and consulting

work. He also owns multiple businesses.


      1
       All section references are to the Internal Revenue Code in effect for the
years at issue, and all Rule references are to the Tax Court Rules of Practice and
Procedure, unless otherwise indicated.
                                           -3-

[*3] I.        Mr. Sellers’ Businesses

          During 2013 and 2014, Mr. Sellers owned multiple businesses.

          A.     Deep Creek

          During 2013 and 2014, Mr. Sellers was the sole shareholder and president of

Deep Creek Management, Inc. (Deep Creek), an S corporation operating out of

Utah. Mr. Sellers was Deep Creek’s only employee; Deep Creek contracted with

PBA for Mr. Sellers’ accounting and consulting services. Mr. Sellers also prepared

Deep Creek’s income tax returns.

          B.     King’s Dominion

          In 2013 and 2014, Mr. Sellers (83%) and Deep Creek (17%) owned King’s

Dominion, a Utah limited liability company (LLC) treated as a partnership for tax

purposes. King’s Dominion had no employees and was in the business of

recovering “defunct real estate loans and semi-tractor trailer loans.” Mr. Sellers

prepared the tax returns for King’s Dominion.

          C.     Mandy Investments

          Mr. Sellers and his wife, Mary Sellers, owned Mandy Investments, LLC.

The Sellerses created Mandy Investments to hold family investments.
                                         -4-

[*4] D.      SS Marine

      In 2013 and 2014, Mr. Sellers (1%) and Deep Creek (99%) owned SS

Marine, a Utah LLC treated as a partnership for tax purposes. SS Marine sold

boats and boat parts and performed boat maintenance and upkeep for marine

enthusiasts in the Salt Lake City area. In 2013 and 2014, SS Marine had

storefronts in North Salt Lake and Orem, Utah.

      Though SS Marine hired employees to run most of the day-to-day

operations, both Mr. and Mrs. Sellers contributed time to the business. Mr. Sellers

performed many of the back-end operations of SS Marine. He managed the bank

accounts, credit lines, and cash reconciliation, and he prepared the company’s tax

returns. Mr. Sellers also received phone calls from the stores’ managers, reviewed

larger vendor orders, and approved boat trade-ins. Mrs. Sellers contributed by

processing payroll for SS Marine employees. She also obtained boat titles from

the Department of Motor Vehicles (DMV) and helped plan the company’s annual

Christmas party.

      As owners of a boat retailer, the Sellerses participated in various boat-related

events. In 2013 and 2014, SS Marine had a booth at a local boat show. The

Sellerses were involved in hauling boats to and from the boat show and appearing

at the boat show as representatives of SS Marine. Mr. Sellers, and occasionally
                                         -5-

[*5] Mrs. Sellers, would also attend boat conferences. Boat conferences allowed

out-of-town boat manufacturers to market their products to dealers by providing

manufacturing plant tours, test drives, and access to vendor representatives.

Conferences often lasted two or three days and required the Sellerses and their

employees to travel out of State.

II.   Mr. Sellers’ 2013 and 2014 Returns

      Mr. Sellers prepared and filed returns on behalf of Deep Creek, King’s

Dominion, and himself. Deep Creek filed a Form 1120S, U.S. Income Tax Return

for an S Corporation, and an amended Form 1120S for 2013. On the amended

Form 1120S, Deep Creek reported gross receipts of $1,065,902 and ordinary

business income of $384,001. Mr. Sellers calculated this income by deducting

$303,039 of nonpassive, passthrough losses along with other deductions.

      King’s Dominion also reported a $6,911 loss on its 2013 Form 1065, U.S.

Return of Partnership Income.

      On his 2013 Form 1040, U.S. Individual Income Tax Return, Mr. Sellers

reported nonpassive losses attributed to SS Marine of $2,961. He also claimed a

$15,652 self-employed health insurance expense deduction.

      For 2014, Deep Creek and Mr. Sellers again reported nonpassive losses

attributed to SS Marine and King’s Dominion. Deep Creek reported a $380,378
                                          -6-

[*6] nonpassive loss from SS Marine and a $97,100 nonpassive loss from King’s

Dominion for a total nonpassive loss of $477,478. Mr. Sellers reported a $3,842

loss from SS Marine.

III.   Procedural History

       The Commissioner sent Mr. Sellers a notice of deficiency for 2013 and 2014

disallowing his 2013 self-employed health insurance expense deduction and

recharacterizing losses from SS Marine and King’s Dominion as passive losses.

Finally, the Commissioner determined accuracy-related penalties under section

6662(a).

       On June 23, 2017, the supervisor of the revenue agent assigned to Mr.

Sellers’ case signed a Civil Penalty Approval Form approving accuracy-related

penalties for Mr. Sellers’ 2013 and 2014 Forms 1040. On July 11, 2017, the

Commissioner sent an IRS Letter 950, also referred to as a “30-day letter,” to Mr.

Sellers informing him of the section 6662(a) accuracy-related penalties.

       While residing in Utah, Mr. Sellers timely filed a petition with this Court

alleging that his losses were nonpassive and that he properly claimed the self-

employment health insurance expense deduction for 2013. He also disputed the

section 6662(a) penalties for 2013 and 2014.
                                         -7-

[*7] The parties stipulated documents that Mr. Sellers argues substantiate his and

Deep Creek’s bases in King’s Dominion and SS Marine. These documents include

various bank account statements for SS Marine. The documents also include an

unexecuted contract for an inventory line of credit issued by GE Commercial

Distribution Finance Corp. and an accompanying guaranty, both dated January 6,

2010. The guaranty lists Deep Creek as a guarantor of the line of credit and is

signed by Mr. Sellers in his capacity as president of Deep Creek, but it is not

signed on behalf of the purported lender.

      The record includes other unexecuted documents. One such document is a

promissory note dated June 1, 2005, between King’s Dominion and Mandy

Investments, the company created to hold the Sellers’ family investments. The

promissory note names King’s Dominion as the borrower and Mr. Sellers and

Deep Creek as the loan’s guarantors. Mr. Sellers is the representative for Mandy

Investments, King’s Dominion, and Deep Creek; however, he signed the note on

behalf of only King’s Dominion, Deep Creek, and himself and not on behalf of

Mandy Investments. Another such document is a business loan agreement also

dated June 1, 2005. Like the promissory note, the business loan agreement was

signed by Mr. Sellers on behalf of King’s Dominion, Deep Creek, and himself but

not for Mandy Investments.
                                         -8-

[*8] The record also includes partial calendars for 2013 and 2014 to substantiate

time Mr. Sellers spent actively engaged in SS Marine.

      At trial, Mr. Sellers testified to having sufficient bases in King’s Dominion

and SS Marine to deduct the losses but provided no documents other than those

already discussed.

                                      OPINION

      After trial, the remaining issues for this Court to decide are whether Mr.

Sellers can substantiate the following: Deep Creek’s basis in King’s Dominion;

Mr. Seller’s and Deep Creek’s bases in SS Marine; Mr. Seller’s material

participation in SS Marine; and Mr. Seller’s entitlement to his self-employed health

insurance expense deduction. If Mr. Sellers and Deep Creek lacked sufficient

bases in the partnerships, their deducted losses are disallowed.2 If Mr. Sellers

materially participated in SS Marine, losses up to the amount of basis would not be

subject to the passive loss limitations under section 469.

I.    Burden of Proof and Jurisdiction

      We have jurisdiction to review and redetermine the Commissioner’s

determinations in a notice of deficiency when a taxpayer timely files a petition




      2
          See sec. 704(d).
                                           -9-

[*9] challenging those determinations.3 Mr. Sellers timely filed a petition

challenging the Commissioner’s determinations in the notice of deficiency,

granting us jurisdiction.4

      Generally, the Commissioner’s determinations in the notice of deficiency are

presumed correct, and the taxpayer bears the burden to prove otherwise.5

However, the Commissioner bears the burden of proof for “any new matter,

increases in deficiency, and affirmative defenses.”6 When the Commissioner

presents a new theory to sustain the deficiency, it is “treated as a new matter when

it either alters the original deficiency or requires the presentation of different


      3
          Sec. 6213(a).
      4
        During the years remaining in issue, Deep Creek was an S corporation and
owned interests in both King’s Dominion and SS Marine. Both King’s Dominion
and SS Marine were subject to the unified audit and litigation procedures of secs.
6221-6234, enacted as part of the Tax Equity and Fiscal Responsibility Act of
1982 (TEFRA), Pub. L. No. 97-248, 96 Stat. 324. The issues before us, however,
do not require adjustments to partnership items of King’s Dominion or SS Marine,
and as a result, the TEFRA provisions are not implicated. It is well established that
whether a partner’s involvement in an entity was active or passive is a partner-level
determination. See Estate of Quick v. Commissioner, 

, 187 (1998),
supplemented by 

(1998). And, while contributions to partnerships
are partnership items, see sec. 301.6231(a)(3)-1(a)(4)(i), Proced. & Admin. Regs.,
the contributions at issue are from years before Deep Creek elected to be treated as
an S corporation. There is no indication that either King’s Dominion or SS Marine
was subject to TEFRA at the time of any of the contributions or guaranties at issue.
      5
          Rule 142(a); Welch v. Helvering, 

, 115 (1933).
      6
          Rule 142(a)(1).
                                          -10-

[*10] evidence. * * * A new theory which merely clarifies or develops the original

determination is not a new matter” for which the Commissioner bears the burden

of proof.7

      The Commissioner bears the burden of proof on the issue of whether Mr.

Sellers can substantiate his and Deep Creek’s bases in his companies. The

Commissioner did not raise the issue of sufficient basis for SS Marine until his

pretrial memo and waited until trial to address Mr. Sellers’ and Deep Creek’s bases

in King’s Dominion. Because the passive loss issue was set forth in the notice of

deficiency, Mr. Sellers bears the burden of proof on that issue.

II.   Bases of Partnerships and Allowed Losses

      A partner may not deduct partnership losses in excess of the partner’s

adjusted basis in the partnership.8 And losses attributed to a partner cannot reduce

that partner’s basis below zero.9

      A partner’s basis in a partnership fluctuates because of various events. A

partner’s outside basis is increased in part by the partner’s distributive share of




      7
          Wayne Bolt & Nut Co. v. Commissioner, 

, 507 (1989).
      8
          Sec. 704(d).
      9
          Sec. 705(a)(2).
                                          -11-

[*11] income and the partner’s contributions to the partnership.10 Any increase in a

partner’s share of liabilities or assumption of partnership liabilities also increases

the partner’s outside basis.11 A partner’s basis is decreased by the partner’s

distributive share of partnership losses, nondeductible expenses, and

distributions.12

       The Commissioner contends that Mr. Sellers cannot show a sufficient basis

in King’s Dominion or SS Marine to deduct the losses. Because the Commissioner

raised this matter after issuing the notice of deficiency, he bears the burden of

showing Mr. Sellers and Deep Creek cannot substantiate sufficient bases.

       To establish his basis in King’s Dominion, Mr. Sellers submitted a

promissory note and the business loan agreement. The agreement states that

Mandy Investments lent over $2 million to King’s Dominion with Mr. Sellers and

Deep Creek as guarantors. Neither contract is fully executed even though Mr.

Sellers is the only person who may sign for all four parties. Even if the loan were

fully executed, King’s Dominion would have incurred the liability on June 1, 2005,




       10
            Secs. 705(a)(1), 722.
       11
            Sec. 752(a).
       12
            Sec. 705(a)(2).
                                        -12-

[*12] 7-1/2 years before 2013. We have no evidence that this loan was outstanding

in 2013 and 2014.

      Not only do the loan documents significantly predate the years at issue, but

they are incomplete records of the partners’ bases in King’s Dominion. Bases

fluctuate in part because of contributions, distributions, losses, and income. Mr.

Sellers had access to current financial records for King’s Dominion but chose not

to provide them to the Court. We thus lack the evidence that would allow us to

evaluate the partners’ bases in King’s Dominion. By demonstrating that Mr.

Sellers had access to but did not provide necessary records, the Commissioner met

his burden of proof to show that Mr. Sellers did not establish his or Deep Creek’s

basis in King’s Dominion.

      When he bears the burden of proof on a matter of substantiation, the

Commissioner will fail to meet that burden if the taxpayer provides additional

information regarding substantiation records.13 Mr. Sellers did not provide

necessary records to substantiate the partners’ bases in King’s Dominion. It is well

established that we may draw an adverse inference from a party’s failure to

introduce evidence available to the party.14 Because Mr. Sellers did not provide

      

. Commissioner, T.C. Memo. 2012-115.
      14
           Abramson v. Commissioner, T.C. Memo. 1987-276, 1987 Tax Ct. Memo
                                                                  (continued...)
                                        -13-

[*13] evidence to demonstrate his basis in King’s Dominion, we will infer he

cannot do so. The Commissioner thus met his burden of proof to show that Mr.

Sellers did not substantiate his or Deep Creek’s basis in King’s Dominion.

      The Commissioner also proved that Mr. Sellers could not establish his basis

in SS Marine. To show Deep Creek’s basis in SS Marine, Mr. Sellers provided a

guaranty on a line of credit financed by GE Commercial Distribution Finance

Corp. dated January 6, 2010. The guaranty shows Deep Creek as the guarantor and

is signed only by Mr. Sellers on behalf of Deep Creek and not GE Distribution

Finance Corp. Mr. Sellers claimed that an identical guaranty exists that shows

himself as a guarantor, but he did not provide this guaranty to the Court.

      The Deep Creek guaranty paints an incomplete picture. The agreement is

dated three years before the first tax year at issue and provides no meaningful

insight into the partners’ bases in 2013 and 2014.

      Other documentation provided by Mr. Sellers fails to establish the partners’

outside bases. SS Marine’s bank account records from 2011 do not shed light on

SS Marine’s bases in 2013 and 2014. The bank account record from January 2014

showing a deposit of $50,000 from Deep Creek might indicate a contribution, but


      14
       (...continued)
LEXIS 276, at *32 (citing Wichita Terminal Elevator Co. v. Commissioner, 

, 1165 (1946), aff’d, 

(10th Cir. 1947)).
                                           -14-

[*14] again, the information is incomplete. And testimony did not adequately fill

those gaps. On questioning from the Commissioner’s counsel, Mr. Sellers

admitted to possessing capital account, financial, and business records for SS

Marine; Mr. Sellers did not provide those records to the Court. Because Mr.

Sellers did not provide those records, we infer that he cannot prove his basis in SS

Marine. Accordingly, we hold that Mr. Sellers did not substantiate his basis or

Deep Creek’s basis in SS Marine.

III.   Material Participation

       The Commissioner contends that Mr. Sellers has passive losses from SS

Marine because he did not materially participate in the business. Section 469(a)

limits the passive losses available to an individual taxpayer. A passive loss is the

aggregate losses from the taxpayer’s passive activities that exceed the aggregate

income from those activities.15 Section 469 generally prohibits deducting passive

losses from unrelated income and allows them to offset only other passive income.

Disallowed passive losses do not disappear; they are suspended and may be used to

offset passive income in a later year.16




       15
            Sec. 469(d)(1).
       16
            Sec. 469(b).
                                         -15-

[*15] A passive activity is a trade or business in which the taxpayer does not

materially participate.17 A taxpayer materially participates in an activity when he

or she is involved on a regular, continuous, and substantial basis.18 When

determining material participation, the activity of a spouse is taken into account.19

The regulations identify safe harbors that satisfy material participation, including a

safe harbor in which the taxpayer participates in the activity for more than 500

hours during the year.20

      A taxpayer may establish participation “by any reasonable means.”21

“Reasonable means * * * may include but are not limited to the identification of

services performed over a period of time and the approximate number of hours

spent performing such services during such period, based on appointment books,

calendars, or narrative summaries.”22 Although “reasonable means” may be


      17
           Sec. 469(c)(1).
      18
           Sec. 469(h)(1).
      19
           Sec. 469(h)(5).
      20
        Sec. 1.469-5T(a), Temporary Income Tax Regs., 53 Fed. Reg. 5725-5726
(Feb. 25, 1988).
      21
        Sec. 1.469-5T(f)(4), Temporary Income Tax Regs., 53 Fed. Reg. 5727
(Feb. 25, 1988).
      22
           Sec. 1.469-5T(f)(4), Temporary Income Tax 

(emphasis
added).
                                         -16-

[*16] interpreted broadly, “a post-event ballpark guesstimate” will not suffice.23

Furthermore, the Court is not “bound to accept the unverified, undocumented

testimony of taxpayers.”24

      Mr. Sellers argues that his narrative summary suffices to establish his

participation in SS Marine. The Court has rarely relied on trial testimony alone to

verify a taxpayer’s material participation. A taxpayer’s testimony regarding his

activities and the approximate hours he engaged in those activities is a “postevent

‘ballpark guesstimate’” and does not meet the taxpayer’s burden of proof for

material participation.25

      When a taxpayer does not provide evidence to support his or her testimony,

we struggle to find material participation. In Williams v. Commissioner, the

taxpayer attempted to prove material participation for his airplane activity, but did

not provide the Court an activity log, maintenance records, maintenance invoices

or contracts, or flight logs.26 The taxpayer also testified to dinner meetings to


      23
       Goshorn v. Commissioner, T.C. Memo. 1993-578, 

,
1501 (1993).
      24
           Bartlett v. Commissioner, T.C. Memo. 2013-182, at *9.
      25
        Speer v. Commissioner, T.C. Memo. 1996-323, 

, 135
(1996) (quoting Goshorn v. 

).
      

. Commissioner, T.C. Memo. 2014-158, at *10-*12, aff’d, 771
                                                                    (continued...)
                                            -17-

[*17] market his plane, but “did not provide any contemporaneous records to

corroborate these dinner meetings.”27 We concluded that he had “not

corroborated” that he had spent sufficient hours on his airplane activity.28

      However, if a taxpayer provides supporting documentation, a narrative

summary may show material participation. In Tolin v. Commissioner, the taxpayer

sought to deduct losses from his horse breeding business.29 During trial, the

taxpayer supported his narrative summary with “telephone records, credit card

invoices, and other contemporaneous materials.”30 The Court found the taxpayer’s

narrative summary to be “an accurate depiction of his thoroughbred activity”

because it was corroborated by “a significant amount of credible third-party

witness testimony and objective evidence.”31 The parties had also stipulated the

taxpayer’s performance of certain activities before trial.32



      26
       (...continued)
F. App’x 365 (9th Cir. 2019).
      

. Commissioner, at *12.
      

. Commissioner, at *25.
      29
           Tolin v. Commissioner, T.C. Memo. 2014-65.
      30
           Tolin v. Commissioner, at *28.
      31
           Tolin v. Commissioner, at *29.
      32
           Tolin v. Commissioner, at *29.
                                         -18-

[*18] Credible testimony from multiple witnesses can also strengthen a taxpayer’s

testimony. In Lamas v. Commissioner, the taxpayer called 10 witnesses who

credibly testified about the taxpayer’s significant work for his businesses.33 Even

three out of the four witnesses called by the Commissioner’s counsel supported the

taxpayer’s position.34 The Court found the one contradictory witness to be not

credible because of his “inconsistent statements and personal conflicts” with the

taxpayer.35 The taxpayer also produced phone records that corroborated testimony

regarding his working hours.36

      In this case, testimony at trial was insufficient to show that Mr. or Mrs.

Sellers materially participated in SS Marine. The testimony was inconsistent, and

Mr. Sellers did not provide corroborating documents. The inconsistency and lack

of corroborating evidence calls into question the credibility of the Sellerses’

testimony.

      Witness testimony at trial was conflicting. Witnesses disagreed on whether

the North Salt Lake store closed in 2014 or 2017 and where boat conferences were



      33
           Lamas v. Commissioner, T.C. Memo. 2015-59, at *19.
      34
           Lamas v. Commissioner, at *23-*24.
      35
           Lamas v. Commissioner, at *33.
      36
           Lamas v. Commissioner, at *33.
                                         -19-

[*19] held. Witnesses did not agree on how many boats SS Marine sold each year,

how often vendor orders occurred, and the frequency of boat trade-ins.

Furthermore, witnesses often gave vague testimony and either guessed how much

time they spent on each activity or provided no timeframe at all. These

deficiencies in testimony could have been resolved through the introduction of

contemporaneous records, which were under the control of Mr. Sellers.

      But Mr. Sellers offered little documentary evidence to corroborate

testimony. Mr. Sellers claimed he spent 39 hours in 2013 on the phone but

produced no phone records. He claimed that he spent 236 hours in 2013 on

inventory, but did not provide any inventory records. Many of the activities the

Sellerses testified to performing (inventory, DMV titling, bank account review,

vendor orders, trade-in review, boat demos, and hauling boats post-boat show)

depended on how many boats SS Marine sold each year, but Mr. Sellers did not

provide any sales invoices or other records for either year at issue. And, as

previously noted, witnesses could not agree on how many boats were sold.

      Mr. Sellers did provide the Court partial calendars for 2013 and 2014. His

assistant created the calendars to help Mr. Sellers stay “on task” with his

accounting clients. That assistant calendared only SS Marine items that took Mr.

Sellers out of the accounting office on weekdays, such as the conferences and boat
                                         -20-

[*20] shows. These calendars “corroborate little more than the dates” of Mr.

Seller’s trips and do not establish how many hours Mr. Sellers spent performing

the calendared activities, which is insufficient.37 Additionally, the hours allocated

to certain activities were determined before the activities occurred and were not

adjusted later to reflect the actual hours devoted to the activities, which makes the

information far less meaningful.38

      A large portion of the Sellerses’ claimed hours stems from boat conferences.

However, Mr. Sellers submitted no credit card records, plane tickets, hotel

reservations, brochures from the conferences, correspondence with conference

holders, or schedule of events to demonstrate a timeframe for these conferences.

Testimony from witnesses differed on how much time they spent at each

conference along with travel time and destination.

      In sum, Mr. Sellers failed to establish that he worked enough hours to be

considered to have materially participated in SS Marine.




      37
       See Rapp v. Commissioner, T.C. Memo. 1999-249, 

,
177 (1999).
      38
       See Fowler v. Commissioner, T.C. Memo. 2002-223, 

, 285 (2002).
                                         -21-

[*21] IV.      Self-Employed Health Insurance Expense Deduction

      Section 162(l)(1) allows a self-employed individual to deduct medical

insurance costs for the taxable year. However, this Court has long held that a

taxpayer bears the burden of proving entitlement to any deductions.39 This burden

requires the taxpayer to maintain adequate records to substantiate the amount of the

deduction.40

      Mr. Sellers claimed a $15,652 deduction for self-employed health insurance

expenses. He provided no documentary proof substantiating the cost of his health

insurance. At trial, he claimed he used health insurance records when filling out

his 2013 tax forms, but he did not provide those records to the Court. He did not

meet his burden of proof to show he is entitled to deduct self-employed health

insurance expenses.

V.    Accuracy-Related Penalties Under Section 6662(a)

      Mr. Sellers is liable for accuracy-related penalties under section 6662(a). In

the notice of deficiency, the Commissioner determined for each year a 20%

accuracy-related penalty due to a substantial understatement of income tax or, in

the alternative, due to negligence or a valuation misstatement. Section 6662(a) and


      39
           Rule 142(a); INDOPCO, Inc. v. Commissioner, 

, 84 (1992).
      40
           Sec. 6001; sec. 1.6001-1(a), Income Tax Regs.
                                         -22-

[*22] (b)(1), (2), and (3) imposes a penalty on “any portion of an underpayment of

tax required to be shown on a return” if the underpayment is due to, among other

reasons, negligence, a substantial understatement of income tax, or a substantial

valuation misstatement. An understatement of income tax is “substantial” if it

exceeds the greater of 10% of the tax required to be shown on the return or

$5,000.41

      “Negligence” includes any “failure to make a reasonable attempt to comply

with the provisions of this title.”42 Negligence has been further defined as a “lack

of due care or failure to do what a reasonable and ordinarily prudent person would

do under the circumstances.”43 Additionally, a taxpayer is negligent if he fails to

maintain sufficient records to substantiate the items in question.44

      The Commissioner bears the burden of production as to the penalty.45 To

satisfy this burden, the Commissioner must present sufficient evidence to show



      41
           Sec. 6662(d)(1)(A).
      42
           Sec. 6662(c).
      43
        Neely v. Commissioner, 

, 947 (1985) (quoting Marcello v.
Commissioner, 

, 506 (5th Cir. 1967), aff’g in part, remanding in part

(1964), and T.C. Memo. 1964-299).
      44
           See Higbee v. Commissioner, 

, 449 (2001).
      45
           Sec. 7491(c).
                                         -23-

[*23] that the penalty is appropriate, unless an available defense exists.46 The

penalty will not apply to any portion of an underpayment for which a taxpayer

establishes that he or she had reasonable cause and acted in good faith.47

      Rule 155 computations will determine whether Mr. Sellers’ underpayment

was attributable to a substantial understatement of income tax for either year at

issue. Regardless, the Commissioner presented evidence establishing that Mr.

Sellers acted with negligence by not maintaining sufficient records to substantiate

items underlying his deductions and nonpassive losses. Furthermore, we cannot

find that Mr. Sellers had reasonable cause or acted in good faith. Mr. Sellers works

as an accountant and accounting consultant. He has expertise in tax, business

formations, and the necessity of maintaining records. He knew, or should have

known, of his obligation to substantiate the items he reported. Because he failed to

do so, the negligence penalty applies.

      The Commissioner also bears the burden to present evidence that the initial

determination to impose penalties was timely approved in writing by the revenue




      46
        Graev v. Commissioner, 

, 493 (2017), supplementing and
overruling in part 

(2016).
      47
           Sec. 6664(c)(1).
                                         -24-

[*24] agent’s immediate supervisor.48 The “initial determination” of a penalty

occurs the earlier of when the Commissioner issues a notice of deficiency49 or

when the Commissioner formally communicates to the taxpayer his penalty

determination.50

      The supervisor of the revenue agent assigned to Mr. Sellers’ case approved

imposing accuracy-related penalties against Mr. Sellers before the Commissioner

mailed Mr. Sellers a “30-day letter” informing him of those penalties.

Accordingly, the Commissioner has met his burden of production regarding these

penalties.

      To reflect the foregoing,


                                                Decision will be entered under

                                        Rule 155.




      48
           Sec. 6751(b)(1).
      49
           Clay v. Commissioner, 

, 248 (2019).
      50
        Belair Woods, LLC v. Commissioner, 154 T.C. __, __ (slip op. at 4) (Jan.
6, 2020).