Tax Court Finds Couple Underreported Business Income

GREG A. NINKE AND JANE M. NINKE,
Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent

United States Tax Court

Filed July 19, 2023

Greg A. Ninke and Jane M. Ninke, pro sese.

Zachary B. Friedman, Rachael J. Zepeda, and Ashleigh R. Wise Friedman, for respondent.

[*2] MEMORANDUM FINDINGS OF FACT AND OPINION

HALPERN, Judge: By notice of deficiency dated February 5, 2020, respondent determined deficiencies in, and accuracy-related penalties with respect to, petitioners' federal income tax as follows:

Year	Deficiency	Penalty §6662(a)1
2015	$26,260	$5,252
2016	11,500	2,300
2017	14,060	2,812

The parties have filed a Stipulation of Settled Issues. The issues for decision are: (1) whether, and the extent to which, for each of the years at issue, petitioners underreported their gross receipts from business and (2) whether, for each of those years, they are liable for an accuracy-related penalty. Other unsettled issues are computational, and we need not address them here.

FINDINGS OF FACT

Preliminary Statement

Before making our findings of fact, we pause to address petitioners' failure to comply with Rule 151, which addresses briefs. We conducted a trial in this case, and, at its conclusion, we ordered the parties to file briefs, setting a schedule for seriatim briefs. Rule 151(e)(3) requires that an opening brief contain proposed findings of fact in the form of numbered concise statements of essential fact, each statement supported by reference to the pages of the transcript or the exhibits or other sources relied on in support of the proposed finding. The Rule directs that proposed findings precede both the points on which the party relies and the party's argument. Petitioners' Seriatim Opening Brief does contain proposed findings of fact in numbered statements. It violates the Rule, however, in that it does not [*3] support those statements with references to transcript pages or Exhibits.

Rule 151(e)(3) also requires that, in an answering or reply brief, a party “set forth any objections, together with the reasons therefor, to any proposed findings of any other party.” Respondent filed his Seriatim Answering Brief, making 108 proposed findings of fact, and petitioners asked for, and were granted, leave to file their Seriatim Reply Brief. However, they filed no reply brief. Because petitioners have failed both to provide us with useable findings of fact and to object to respondent's proposed findings, we must conclude that they have conceded respondent's proposed findings of fact as correct except to the extent unsupported by, or inconsistent with, evidence in the record. See, e.g., Jonson v. Commissioner, 118 T.C. 106, 108 n.4 (2002), aff'd, 353 F.3d 1181 (10th Cir. 2003).

Stipulation

The parties have stipulated certain facts and the authenticity of certain documents. The facts stipulated are so found, and the documents stipulated are accepted as authentic.

Residence

When petitioners filed the Petition, they resided in Tempe, Arizona.

Petitioners' Businesses

During all years at issue, Mr. Ninke operated Tanner Media Productions, which provided pornographic websites and other forms of adult entertainment. During 2015, he operated an electronic book publishing business under the name Tanner Media Publishing. During 2016 and 2017, he had an Uber and Lyft driving business. During 2017, Mrs. Ninke worked as a model for one of her husband's websites.

Petitioners' Bank Accounts and Prepaid Debit Card Accounts

During the years at issue, petitioners had between 12 and 20 accounts at various banks, including Bank of America, E*Trade, Paxum, Salliemae, SunTrust Bank, US Bank, and TCF National Bank. Petitioners also maintained prepaid debit card accounts at financial service providers, including Paxum, FirstChoicePay/Payoneer, and NetSpend. Mr. Ninke received at least some payments for his [*4] businesses by way of direct bank deposits and additions to one of his prepaid debit cards.

Petitioners' Returns

For the years at issue, petitioners made joint income tax returns on Forms 1040, U.S. Individual Income Tax Return. For each of those years, they included with Form 1040 one or more Schedules C, Profit or Loss From Business. For each year, they included a Schedule C for Tanner Media Productions (Schedule C–1). For 2015, they included a Schedule C for Tanner Media Publishing (Schedule C–2). During 2017, Ms. Ninke received gross receipts from her modeling business, but petitioners did not report any income from that business on their 2017 return. The parties refer to respondent's adjustment for unreported gross receipts for Ms. Ninke's modeling business as the “Schedule C–3” adjustment (and so shall we).

2015 Return, Schedules C–1 and C–2²

On the 2015 Schedule C–1, petitioners reported gross receipts of $191,121, expenses of $175,261, a separately listed expense of $1,939 for business use of their home, and a net profit of $13,921. On the 2015 Schedule C–2, they reported gross receipts of $543, expenses of zero, and a net profit of $543.

2016 Return, Schedule C–1

On the 2016 Schedule C–1, petitioners reported gross receipts of $66,847, expenses of $66,240, and a net profit of $607.

2017 Return, Schedule C–1

On the 2017 Schedule C–1, petitioners reported gross receipts of $20,728, expenses of $16,582, and a net profit of $4,146.

[*5] Respondent's Examination

Respondent examined petitioners' returns for the years at issue. Revenue Agent (RA) Ian Smith conducted the examination. Petitioners did not maintain proper records for their Schedule C businesses. To determine whether petitioners had reported all receipts from those businesses, RA Smith conducted a bank deposits analysis, comparing reported Schedule C receipts to bank deposits. He treated the prepaid debit card accounts as if they were checking accounts. He reviewed the account statements that petitioners provided to him. He created spreadsheets, wherein he listed all deposits made in the respective accounts, identified the source of each deposit, and categorized each (i.e., transfer, deposit, loan, refund, adjustment, etc.). He then created a summary sheet for each year, on which he entered the year's deposits, subtracted deposits from identifiable nontaxable sources, e.g., bank-to-bank transfers, counter credits, and items such as Social Security disability payments, and compared the difference with the gross income petitioners reported for the year. For each year, the difference exceeded petitioners' reported gross income, and he treated the difference as unreported gross receipts from petitioners' Schedule C businesses.

2015 Adjustments

RA Smith determined 2015 Schedule C–1 unreported gross receipts of $20,132, which he computed as follows:

Schedule C–1 bank deposits	$408,830
Plus: FirstChoicePay deposits	4,367
Plus: NetSpend deposits	4,685
Total Schedule C–1 deposits	$417,882
Less: Excludable deposits	203,329
Less: Bills.Com and NetSpend adjustments	3,300
Total taxable Schedule C–1 deposits per exam	$211,253
Less: Schedule C–1 receipts per return	191,121
Schedule C–1 adjustment	$20,132

[*6] RA Smith determined 2015 Schedule C–2 unreported gross receipts of $2,052, which he computed as follows:

Schedule C–2 bank deposits	$2,595
Less: Schedule C–2 receipts per return	543
Schedule C–2 adjustment	$2,052

In total, RA Smith made 2015 Schedule C adjustments of $22,184, computed as follows:

Schedule C–1 adjustment	$20,132
Schedule C–2 adjustment	2,052
Schedule C adjustments	$22,184

The parties stipulate that an additional $3,190 of deposits is excludable 2015 Schedule C–1 deposits, which they further stipulate reduces RA Smith's 2015 Schedule C–1 adjustment to $16,942. They stipulate the following 2015 Schedule C gross receipts in dispute:

Schedule C–1 adjustment	$16,942
Schedule C–2 adjustment	2,052
Total	$18,994

On brief, respondent does not mention the stipulated $3,190 of additional Schedule C–1 excludable deposits. However, he concedes “additional” 2015 Schedule C–1 excludable deposits of $4,540. Respondent proposes that we find a 2015 Schedule C–1 adjustment of $15,592, which equals RA Smith's Schedule C–1 adjustment of $20,132 less $4,540 ($15,592 = $20,132 − $4,540). That would result in the following 2015 Schedule C gross receipts in dispute:

Schedule C–1 adjustment	$15,592
Schedule C–2 adjustment	2,052
Total	$17,644

Were we to subtract from RA Smith's Schedule C–1 adjustment of $20,132 both the stipulated $3,190 and the conceded $4,540 of additional excludable deposits, the resulting 2015 Schedule C–1 adjustment would be $12,402 ($12,402 = $20,132 − $3,190 − $4,540).

[*7] That would result in the following 2015 Schedule C gross receipts in dispute:

Schedule C–1 adjustment	$12,402
Schedule C–2 adjustment	2,052
Total	$14,454

2016 Adjustment

RA Smith determined 2016 Schedule C–1 unreported gross receipts of $24,595, which he computed as follows:

Schedule C–1 bank deposits	$185,730
Plus: FirstChoicePay deposits	16,370
Plus: NetSpend deposits	69
Total Schedule C–1 deposits	$202,169
Less: Excludable deposits	110,728
Total taxable Schedule C–1 deposits per exam	$91,4423
Less: Schedule C–1 receipts per return	66,847
Schedule C–1 adjustment	$24,5954

RA Smith did not determine any 2016 Schedule C–2 unreported deposits.

The parties stipulate that an additional $46 of deposits is excludable 2016 Schedule C–1 deposits, which they further stipulate reduces RA Smith's 2016 Schedule C–1 adjustment to $24,549.

On brief, as for 2015, respondent does not mention the stipulated additional $46 of excludable deposits but concedes “additional” 2016 excludable deposits of $46. Respondent proposes that we find a 2016 Schedule C–1 adjustment of $25,548 (apparently correcting the $1 math error in the stipulation).

Were we to subtract from RA Smith's Schedule C–1 adjustment of $24,594 both the stipulated and conceded adjustments of $46, the [*8] resulting Schedule C–1 adjustment would be $24,502 ($24,502 = $24,594 − $46 − $46).

2017 Adjustment

RA Smith determined 2017 Schedule C–1 unreported gross receipts of $29,642, which he computed as follows:

Schedule C–1 bank deposits	$109,080
Plus: FirstChoicePay deposits	9,507
Plus: NetSpend deposits	4,759
Total Schedule C–1 deposits	$123,346
Less: Excludable deposits	72,976
Total taxable Schedule C–1 deposits per exam	$50,370
Less: Schedule C–1 receipts per return	20,728
Schedule C–1 adjustment	$29,642

RA Smith did not determine any 2017 Schedule C–2 unreported deposits.

RA Smith determined 2017 Schedule C–3 unreported gross receipts of $3,784.

In total, RA Smith made 2017 Schedule C adjustments of $33,426.

Schedule C–1 adjustment	$29,642
Schedule C–3 adjustment	3,784
Schedule C adjustments	$33,426

The parties stipulate that an additional $1,387 of deposits is excludable 2017 Schedule C–1 deposits, which they further stipulate reduces RA Smith's 2017 Schedule C–1 adjustment to $28,255. They stipulate the following 2017 Schedule C gross receipts in dispute:

Schedule C–1 adjustment	$28,255
Schedule C–3 adjustment	3,784
Total	$32,039

On brief, as for 2015 and 2016, respondent does not mention the stipulated additional $1,387 of 2017 Schedule C–1 excludable deposits [*9] but concedes “additional” 2017 Schedule C–1 excludable deposits of $1,518. Respondent proposes that we find a 2017 Schedule C–1 adjustment of $28,124, which equals RA Smith's Schedule C–1 adjustment of $29,642 less $1,518 ($28,124 = $29,642 − $1,518). That would result in the following 2017 Schedule C gross receipts in dispute:

Schedule C–1 adjustment	$28,124
Schedule C–3 adjustment	3,784
Total	$31,908

Were we to subtract from RA Smith's Schedule C–1 adjustment of $29,642 both the stipulated $1,387 and the conceded $1,518 of additional excludable deposits, the resulting 2017 Schedule C–1 adjustment would be $26,737 ($26,737 = $29,642 − $1,387 − $1,518). That would result in the following 2017 Schedule C gross receipts in dispute:

Schedule C–1 adjustment	$26,737
Schedule C–3 adjustment	3,784
Total	$30,521

Penalties

RA Smith properly obtained written supervisory approval of an accuracy-related penalty for each year at issue.

Trial Exhibits

At trial, we received into evidence from petitioners lists of deposits that they believe respondent should have accepted as excludable deposits. Many of the deposits on petitioners' lists were among those respondent allowed while others petitioners sourced to bank accounts and prepaid debit card account statements that they had not identified to RA Smith. Petitioners conceded at trial at least eight bank accounts or prepaid debit card accounts for which they had provided no information to RA Smith.

[*10] OPINION

I. Introduction

To reiterate, the issues we must decide are (1) respondent's adjustments increasing petitioners' gross receipts from their Schedule C business activities and (2) the accuracy-related penalties.

II. Burden of Proof

Petitioners bear the burden of proof. See Rule 142(a).⁵ Nevertheless, because this case involves unreported income, respondent must make a minimal evidentiary showing connecting petitioners with an alleged income-producing activity or demonstrate that they actually received unreported income. See Walquist v. Commissioner, 152 T.C. 61, 67 (2019). The requisite evidentiary foundation to connect a taxpayer with an income-producing activity is minimal and need not include direct evidence. See, e.g., Banister v. Commissioner, T.C. Memo. 2008-201, 2008 WL 3925877, at *2, aff'd, 418 F. App'x 637 (9th Cir. 2011).

Petitioners' Schedule C businesses provided a likely income-producing source for the disagreed cash deposits, and, in any event, for purposes of sustaining an adjustment in a notice of deficiency increasing gross income, a bank deposit is prima facie evidence of income. Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). Respondent has carried his burden of connecting petitioners with an income-producing activity.

Respondent also bears the burden of production with respect to the penalties, which we discuss infra.

III. Unreported Income

A. Bank Deposits Analysis

Gross income includes “income derived from business.” §61(a)(2). Taxpayers must maintain books and records sufficient to establish their income and expenses. §6001; Treas. Reg. § 1.6001-1(a). If they fail to [*11] do so, the Commissioner may reconstruct income through any reasonable method that clearly reflects income. §446(b); Petzoldt v. Commissioner, 92 T.C. 661, 693 (1989). This Court has long accepted the bank deposits method for this purpose. Clayton v. Commissioner, 102 T.C. 632, 645 (1994). The bank deposits method assumes all money deposited in a taxpayer's bank account during a given period constitutes either an item of gross income or a gross receipt. See DiLeo v. Commissioner, 96 T.C. 858, 868 (1991). If, however, the Commissioner has knowledge that a deposit is from an excludable source (e.g., is a gift) he must exclude it from his tally of taxable deposits. See id.

Because respondent believed that petitioners had not reported all income from their Schedule C businesses for the years at issue, and because they had not maintained proper business records, respondent's agent, RA Smith, conducted a bank deposits analysis, which resulted in his determination that petitioners had underreported their Schedule C income for each of the years at issue. Neither at trial nor on brief do petitioners challenge the accuracy of the account statements on which RA Smith relied.

B. Parties' Arguments

1. Petitioners' Argument

Petitioners identify as the only fault with respondent's bank deposits analysis his failure to treat as nontaxable transfers between bank accounts all cash deposits that they made during the years at issue. They spend approximately half of their brief listing individual cash deposits and withdrawals from their bank accounts and prepaid debit card accounts during the years at issue. They show deposits totaling $28,550 and withdrawals totaling $44,639. They ask us to find that Mr. Ninke's clients did not pay him in cash. That presumed fact, together with the excess of withdrawals over deposits, they argue, “strongly suggests that the deposits made by the petitioners was [sic] a transfer, made out of cash previously withdrawn by petitioners. There is no reasonable explanation for the cash deposits other than that the funds were being transferred.” They concede that “respondent accepted that certain cash deposits were actually transfers, but only when . . . the cash deposit was close in time and/or in [an] amount [equal] to the prior withdrawal.” They argue: “[R]espondent should not be allowed to arbitrarily decide whether the petitioner[s] deposited their cash withdrawal fast enough or in an amount close enough to the withdrawal.”

[*12] 2. Respondent's Arguments

Respondent rejects petitioners' proposed finding that Mr. Ninke's clients did not pay him in cash as “uncorroborated, self-serving, and not supported by credible evidence.” Respondent also rejects petitioners' claim that RA Smith acted arbitrarily in treating only some cash deposits as excludable deposits. He points out that, despite petitioners' lack of records, RA Smith treated as deposits from excludable sources deposits that he could associate with a withdrawal shown on a bank account statement provided to him by petitioners. Respondent adds that, in support of their claim that all cash deposits to their bank accounts were no more than nontaxable transfers from other of their accounts, they rely in part on claimed withdrawals from bank accounts and prepaid debit accounts for which they provided no statements to RA Smith (and which did not figure into his tally of bank deposits). With post-examination adjustments to be discussed, respondent claims that RA Smith did not err in his bank deposits analysis.

C. Discussion

Petitioners' burden is to identify additional cash deposits from excludable sources beyond the deposits accepted as such by RA Smith. Their claim is that all cash deposits during the years at issue were transfers from one or another of their bank accounts. It is well settled that we need not accept a taxpayer's self-serving testimony when the taxpayer fails to present credible, corroborative documentary evidence. See, e.g., Shilgevorkyan v. Commissioner, T.C. Memo. 2023-12, at *7. At more than one point during the trial, we explained to petitioners that their task on brief would be to tie deposits that respondent had not treated as coming from an excludable source to a transfer or a withdrawal from an account previously identified to respondent. They have made no attempt to do so. Showing that cash withdrawals exceeded cash deposits for the years at issue does not prove that any deposit was of cash withdrawn from the same account or any other account of petitioners. And even were we to accept petitioners' claim that Mr. Ninke's clients did not pay him in cash, their introduction at trial of evidence of withdrawals from bank accounts and prepaid debit card accounts that they had not disclosed to RA Smith raises the possibility of unreported income (whether paid in cash or otherwise) deposited to undisclosed accounts, withdrawn as cash, and redeposited [*13] in accounts of which RA Smith did know. Such deposits would not ultimately be from an excludable source.

Petitioners have failed to carry their burden of showing cash deposits from excludable sources more than the cash deposits accepted as such by respondent.

Finally, we have the issue of the parties' stipulating additional Schedule C–1 excludable deposits of $3,190, $46, and $1,387 for 2015, 2016, and 2017, respectively, while, on brief, respondent — not mentioning those stipulations — concedes “additional” Schedule C–1 deposits of $4,540, $46, and $1,518 for those years. We resolve that discrepancy in petitioners' favor and assume that respondent means for each year that the sum of the two amounts be considered additional Schedule C–1 deposits from excludable sources.

We sustain positive adjustments to Schedule C gross receipts of $14,454, $24,502, and $30,521 for 2015, 2016, and 2017, respectively.

IV. Accuracy-Related Penalty

A. Introduction

Section 6662(a) and (b)(1) provides for an accuracy-related penalty of 20% of the portion of an underpayment of tax required to be shown on a return attributable to negligence or disregard of rules and regulations (without distinction, negligence). Section 6662(a) and (b)(2) provides for the same penalty on the portion of an underpayment of tax attributable to any substantial understatement of income tax. In the case of an individual, there is a substantial understatement of income tax for a year if the amount of the understatement exceeds the greater of (1) 10% of the tax required to be shown on the return for the tax year or (2) $5,000. §6662(d)(1)(A). Section 6664(c)(1) provides a reasonable cause exception to imposition of the section 6662(a) accuracy-related penalty on that portion of an underpayment for which it is shown that there was reasonable cause and the taxpayer acted in good faith.

Only one accuracy-related penalty may be applied with respect to any given portion of an underpayment even if that portion is subject to the penalty on more than one of the grounds set out in section 6662(b). Treas. Reg. § 1.6662-2(c).

[*14] B. Burden of Production

1. Introduction

The Commissioner bears a burden of production with respect to the accuracy-related penalty, including making a prima facie case that the section 6751(b)(1) requirement for written supervisory approval has been met. E.g., DeCrescenzo v. Commissioner, T.C. Memo. 2023-7, at *18. Section 6751(b)(1) provides: “No penalty under this title shall be assessed unless the initial determination of such assessment is personally approved (in writing) by the immediate supervisor of the individual making such determination or such higher level official as the Secretary may designate.”

2. Penalty Approval

The parties stipulate, and we have found, that RA Smith properly obtained written supervisory approval of an accuracy-related penalty for each year at issue. Respondent has made a prima facie case with respect to the penalty approval required by section 6751(b)(1).

3. Grounds for the Penalty

Respondent has also made a prima facie case for the accuracy-related penalties on the grounds that, for each year at issue, petitioners' underpayment of tax resulted from negligence. Petitioners did not maintain proper records for their Schedule C businesses. Negligence includes any failure by the taxpayer to keep adequate books and records or to substantiate items properly. See Diesel Country Truck Stop, Inc. v. Commissioner, T.C. Memo. 2000-317, 2000 WL 1478654, at *17; Treas. Reg. § 1.6662-3(b)(1).

Respondent claims as an alternative basis for the accuracy-related penalty that petitioners substantially understated their income tax for the years at issue. We need not reach that question.

C. Burden of Proof

Respondent having met his burden of production with respect to the penalty, the burden of proof (viz, the risk of nonpersuasion) is with petitioners and includes the burden to prove any affirmative defense. See, e.g., Fabian v. Commissioner, T.C. Memo. 2022-94, at *38. Petitioners argue that they acted reasonably in reporting any income reported to them on information returns and did not believe that they [*15] had any additional cash receipts that were income. Petitioners ignore that RA Smith found unreported income for each year at issue well in excess of cash deposits that petitioners claim were redeposits of transfers or withdrawals from their various bank accounts and prepaid debit card accounts. Petitioners have failed to prove that there was reasonable cause for their underpayments and that they acted in good faith.

We sustain the accuracy-related penalties for the years at issue.

V. Conclusion

To reflect the foregoing,

Decision will be entered under Rule 155.