Woodall v. C.I.R. ( 1992 )

IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
No. 91-4572
PHYLLIS A. WOODALL and
JEANNIE S. COUTTA,
Petitioners,
versus
COMMISSIONER OF INTERNAL REVENUE,
Respondent.
Appeal from a Decision of the United States Tax Court
(June 12, 1992)
Before WILLIAMS and HIGGINBOTHAM, Circuit Judges, and McNAMARA,*
District Judge.
HIGGINBOTHAM, Circuit Judge:
Phyllis Woodall and Jeannie Coutta appeal a Tax Court judgment
finding additional taxes due in their 1982, 1983, and 1984 tax
years. The dispute arises out of fire losses to two partnership
assets presenting issues of valuation and accounting for income.
We affirm.
I.
Woodall and Coutta were equal partners in El Paso
Cosmopolitan, a partnership operating two nightclubs, the Naked
Harem Show Bar and the El Paso Cosmopolitan Topless Show Bar. On
*
District Judge of the Eastern District of Louisiana,
sitting by designation.
April 5, 1982, the Cosmopolitan suffered extensive fire damage.
Woodall estimated the value of the partnership assets destroyed at
$90,000. The partnership pursued an insurance claim, but the
insurer was insolvent and the partnership had no reasonable
prospect of recovery by the end of 1982. The partnership claimed
a deduction of $78,441 for the fire loss at the Cosmopolitan on its
1982 return. However, the schedule L balance sheet attached to the
return, prepared by taxpayers' accountant, stated that the adjusted
basis of all depreciable partnership assets at the beginning of
1982 was only $8,541.
On April 21, 1982, the Naked Harem sustained extensive fire
damage. The partnership filed an insurance claim of $122,500, but
received only $50,000 from the receivership estate of the insurance
company. During 1983, the partnership spent $25,272 repairing fire
damage at the Naked Harem and purchased replacement assets
totalling $13,093. In August 1983, the partnership purchased the
land, building and improvements at 6345 Alameda for $245,000. The
partnership reported the $50,000 insurance recovery as taxable
income on its 1983 tax return.
Upon audit of the taxpayers' and the partnership's returns for
1982-1984, the IRS increased the partnership's taxable income for
each year, with excess income attributed equally to each partner.
The revenue agent used the bank deposits plus cash expenditures
method to reconstruct the gross receipts of the partnership and the
taxpayers. The revenue agent also disallowed $69,991 of the
partnership's claimed fire loss.
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The IRS gave deficiency notices and Woodall and Coutta filed
petitions to the Tax Court.
II.
Internal Revenue Code § 165(a) allows a deduction for a loss
sustained during the taxable year not compensated for by insurance
or otherwise. The amount of available deductible loss is limited
to the adjusted basis of the property at the time of the loss. 26
U.S.C. § 165(b). The Tax Court determined that the adjusted basis
of the assets lost in the Cosmopolitan fire was $8,541 and
disallowed the partnership's deduction of losses above that amount.
The Tax Court valuation rested on the adjusted basis on the balance
sheet statement submitted by the partnership with its 1982 return.
The taxpayers argue first that the Tax Court could not rely
upon the balance sheet statement alone to prove that the adjusted
basis of the property was only $8,54l, relying upon Portillo v.
Commissioner, 932 F.2d 1128 (5th Cir. 1991). In Portillo, the IRS
issued a deficiency notice solely on the basis of an inconsistency
between the taxpayer's return and the figures on another party's
1099 form. We held that it was arbitrary and capricious to find a
deficiency without investigating or corroborating the figures in
the 1099 form provided by a third party. 932 F.2d at 1134. This
case does not raise the concern of Portillo, however, because the
IRS here relied upon the taxpayer's statement, not another's
statement.
Second, the taxpayers argue that they have disproved the
accuracy of the $8,541 figure because that figure would require
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that deductions had been taken in prior years in excess of those
legally allowed under 26 U.S.C. § 1011. A taxpayer challenging the
IRS's disallowance of a deduction bears the burden of proof. Laney
v. Commissioner, 674 F.2d 342, 349 (5th Cir. 1982). The taxpayers
presented evidence at trial that the original cost basis in the
property was $93,569 and that the legally allowable depreciation in
prior years was $16,421. They argue that this evidence meets their
burden of proving the adjusted basis of their loss.
In Laney v. Commissioner, 674 F.2d 342 (5th Cir. 1982), we
held that where the IRS relied on facts in a schedule filled out
and signed by the taxpayer, the taxpayer could not meet its burden
of proof without financial records or other documentary evidence to
refute or contradict the reliability of the schedule. The
taxpayer's testimony that the facts in the schedule were untrue was
insufficient to rebut the tax return. Id.
The evidence here tending to contradict the schedule was
weaker than in Laney. Here, there was only Woodall's claim that
the property was worth more than $8,541. She did not state
unequivocally that the deductions had not been claimed in prior
years. She did not provide a credible explanation for the
allegedly inaccurate information on the schedule nor did she
present her tax returns for previous years to support her
contention. The taxpayers did not prove that the Tax Court's
findings were clearly erroneous.
Taxpayers suggest that even if they did take excessive
deductions in prior years, the proper result is to allow them the
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1982 loss deduction and force the IRS to reopen their returns for
those prior years. The amount of deductible loss is limited to the
greater of the amount allowed as deductions or allowable as
deductions. 26 U.S.C. § 1016. An amount has been "allowed" in a
prior year if the Commissioner has not challenged it. Kilgroe v.
United States, 664 F.2d 11687, 1170 (10th Cir. 1981). Thus, the
Code contemplates allowed depreciations greater than those
allowable by law. The IRS need not reopen the taxpayer's past
returns but may use the lower adjusted basis resulting from excess
depreciation in calculating the 1982 allowable loss.
III.
The taxpayers assert that the $50,000 insurance recovery from
the Naked Harem fire was non-taxable because the partnership
purchased replacement property "similar or related in service or
use" to the property converted within the time period required by
26 U.S.C. § 1033. The Tax Court agreed that the insurance recovery
was non-taxable to the extent of the repairs made and the
replacement assets bought for the bar, $38,365 total, but held that
the purchase of the land, building and improvements at 6345 Alameda
did not qualify as property "similar or related in service or use."
The taxpayers rely on Davis Regulator Co. v. Commissioner, 36
B.T.A. 437 (1937) and Rev. Rul. 83-70, 1983-1 C.B. 189, for the
proposition that the purchase of a building can be a replacement
property for an involuntarily converted leasehold. This
proposition is sound. The taxpayers' problem is that they did not
suffer an involuntary conversion of their leasehold. The loss was
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only to their improvements. In Davis Regulator, in contrast, the
taxpayer had been forced to sell its leasehold because of a threat
of condemnation. The fire in the Naked Harem did not force the
taxpayers to buy the nightclub buildings; their lease interest had
remained intact. In fact, taxpayers reopened the nightclub before
deciding to purchase the building. The purchase of the building
replaced no damaged property and the funds used for its purchase do
not fall within § 1033.
IV.
Finally, taxpayers argue that the calculation of taxable
income using the bank deposits plus cash expenditures method of
calculating income was arbitrary and capricious and therefore not
entitled to a presumption of correctness. Under the bank deposits
plus cash expenditures method, the IRS agent totals all deposits
into taxpayers' accounts during the year. The agent then looks at
the amount claimed by the taxpayer as business expenses for the
year and deducts from that amount all business checks written by
the taxpayer that year. Any amounts claimed as business expenses
but not accounted for by a business check are considered cash
expenditures. Total income is the amount of bank deposits plus
cash expenditures.
We have approved the use of this indirect method of proving
income, particularly where the incompleteness of the income records
makes other methods difficult. Mallette Bros. Const. Co. v.United
States, 695 F.2d 145, 148 (5th Cir. 1983) (IRS is authorized to use
whatever method seems appropriate to reconstruct taxpayer's
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income). We see no reason why this method may not be used to
determine partnership income and the taxpayers have pointed to no
general problem with applying the method here. The burden is on
the taxpayer to demonstrate any unfairness or inadequacy of the
method. Price v. United States, 335 F.2d 671, 676 (5th Cir. 1964).
The taxpayers object specifically to the way their taxable
income was calculated. First, they argue that the agent double-
counted distributions made from the partnership to the individual
partners. The Tax Court found, however, that the agent excluded
amounts which were transferred from the partnership account to the
taxpayers' personal accounts. The agent counted only amounts that
were deposited directly from partnership cash proceeds into
personal accounts. If she had not counted these amounts they would
not have been counted at all because they were never deposited into
the partnership account. This calculation correctly reflects the
amount of income earned by the partnership.
Second, the taxpayers argue that the agent erred in not taking
into account the effects of capital contributions made by the
partners to the partnership during 1982. The IRS argues that the
taxpayers cannot point to any evidence in the financial records to
indicate that these contributions actually occurred. The taxpayers
assert that these capital contributions are evidenced by its 1982
tax return which claims partners' contributions to partnership
capital totaling $16,172 and that it would be inconsistent to hold
them bound by their statement of adjusted basis but not for their
capital contributions. This argument ignores the difference
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between an admission against interest and a self-serving statement.
The revenue agent found no checks representing capital
contributions to the partnership in any of the taxpayers' personal
bank accounts. The taxpayers do not dispute this finding. Any
contributions in the form of property or undeposited cash would not
affect the income calculation. Therefore, the taxpayers have not
shown that the agent's computation of income is incorrect.
Third, the taxpayers argue that the agent erred in failing to
count as business expenses checks drawn on the partnership accounts
and made payable to "Cash." Taxpayers claim that this money was
used to pay business expenses to suppliers who would not take the
partnership's checks. The Tax Court found that the taxpayers had
presented no evidence to support their contentions other than
Woodall's "vague testimony" which it did not find credible. The
Tax Court's determination that these checks were not sufficiently
documented to be deductible as business expenses was not clearly
erroneous.
The judgment of the Tax Court is AFFIRMED.
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