Scott L. Reed and Stacy N. Reed v. Commissioner of Internal Revenue, T.C. Memo. 2026-64, Docket No. 13757-20 (August 5, 2026)

The United States Tax Court’s recent decision in Scott L. Reed and Stacy N. Reed v. Commissioner of Internal Revenue, T.C. Memo. 2026-64 (filed August 5, 2026), offers tax professionals a valuable case study in the federal income tax consequences of aggressive tax positions paired with inadequate recordkeeping. The case involved Scott L. Reed, a real estate development consultant, and Dr. Stacy N. Reed, a medical doctor, who during the taxable years 2012 through 2015 received income from a myriad of sources and were involved in several highly complex projects. These projects spanned historic real estate development, the starting of a private dermatology practice, and the commercial sale of reclaimed wood. Across these varied activities, however, the Court noted that “recordkeeping left much to be desired”.

The Commissioner of Internal Revenue issued a Notice of Deficiency determining that the taxpayers underreported ordinary income from multiple sources, realized unreported net capital gains, improperly claimed Schedule C business expense deductions and Schedule E unreimbursed partnership expenses, and were not entitled to a claimed Section 38 general business credit. The Commissioner also asserted additions to tax under Section 6651(a)(1) for late filing and accuracy-related penalties under Section 6662(a). Judge Toro, writing for the Tax Court, sustained the vast majority of the Commissioner’s deficiency determinations, concluding that “the Reeds have carried their burden of proof only with respect to some of the issues that remain”. For Certified Public Accountants (CPAs) and Enrolled Agents (EAs), the decision highlights the strict application of IRC Section 162 expense substantiation standards, the stringent boundaries of the Lohrke exception, the absolute binding nature of the form of chosen business transactions, and the fatal consequences of failing to address issues in post-trial briefing.

Factual Background

Mr. Scott L. Reed spent his early life around construction before working as a real estate consultant at Arthur Andersen and Standard & Poor’s. He specialized in real estate development subsidized by tax credits, specifically historic preservation rehabilitation credits, and served as a consultant for the United States Navy assisting in the disposal of closed bases. Mr. Reed later established Reed Realty Advisors, LLC (RRA), a single-member limited liability company treated as a disregarded entity for federal income tax purposes. RRA was engaged in real estate consulting and development, assisting clients with site selection, property acquisition, coordinating contractors, and monitoring construction progress.

RRA hired Linda Hernandez (Mr. Reed’s mother) to prepare architectural models, Bruce Reed (Mr. Reed’s father) to consult on construction matters, and Alex Dzyuba to manage construction and import fixtures. Despite operating a specialized real estate advisory firm, the taxpayers did not introduce complete books and records for RRA at trial, and Mr. Reed frequently used the couple’s personal bank accounts to deposit and withdraw funds related to RRA’s business.

Dr. Stacy N. Reed finished her medical residency in Arkansas before returning to Portland, Oregon, where she worked for Allergy, Asthma & Dermatology Associates, and subsequently established her own private medical practice, Reed Dermatology Northwest (RDNW).

During the taxable years at issue, Mr. Reed and RRA were involved in three key real estate development projects in Arkansas and Alabama:

Main Street Lofts, LLC (MSL): Formed in April 2012 to acquire and rehabilitate several commercial buildings in Little Rock, Arkansas. Mr. Reed held his manager and member interest through Reed Property Group 3, LLC, a disregarded entity. MSL secured a construction loan agreement from Riverside Bank for up to $3,182,000, which the taxpayers personally guaranteed alongside investors Wooten Epes and Brian Corbell. The project faced extensive obstacles, including a building fire, a flood caused by a damaged fire hydrant, and a March 2015 legislative amendment to Arkansas Code Section 26-51-2204(a)(2) that severely capped historic tax credits.
K Lofts, LLC (K Lofts): Formed to rehabilitate a commercial property in Little Rock. Mr. Reed held a manager and member interest through K Lofts Member One, LLC, a disregarded entity. K Lofts borrowed $1,375,000 from IBERIABANK, guaranteed by Mr. Reed and Brian Corbell. During construction, a back wall collapsed while being filled with concrete, and the project suffered from burst pipes and break-ins.
TJTOWER, LLC (TJ Tower): A historic development project in Birmingham, Alabama, in which Mr. Reed held an indirect interest through Reed Property Group 5, LLC, a disregarded entity. TJ Tower issued a Schedule K-1 to Mr. Reed’s disregarded entity reflecting $21,065 in interest income for the 2015 tax year.

To fund the escalating costs of these cash-strapped projects, Mr. Reed made substantial payments from the couple’s personal accounts directly to third-party vendors and contractors. The taxpayers later claimed these payments as deductible Schedule C trade or business expenses of RRA, reporting total Schedule C deductions of $131,647 in 2012, $346,980 in 2013, $308,476 in 2014, and $91,548 in 2015. Additionally, in 2014 and 2015, Mr. Reed transferred approximately $811,000 from personal accounts directly to MSL and K Lofts. The project entities tracked these cash transfers as “Scott Reed Float Loan” and “Scott Reed Short Term/Long Term Loan” accounts. On their 2014 and 2015 federal income tax returns, the taxpayers deducted these direct capital transfers on Schedule E as “unreimbursed partnership expenses,” claiming $486,796 in 2014 and $353,775 in 2015.

Furthermore, the taxpayers engaged in several other transactions:

Reclaimed Wood Business: Mr. Reed collected free reclaimed wood from truck beds in Arkansas and sold it to Green Star, receiving bank deposits of $10,186 in 2013, $32,981 in 2014, and $5,200 in 2015. The taxpayers reported a fraction of these receipts on Schedules C for RRA in 2013 and 2014, and reported nothing for 2015.
Farmland Lease: In 2013, Mr. Reed entered into an oral agreement to lease farmland in Oregon, paying $50,000 in quarterly installments, which they deducted as rent on Schedule F before purchasing the property a year later.
Rental Property: The taxpayers owned rental property in Arkansas managed by Dixon Ventures, which issued a Form 1099-MISC for 2014 reporting $38,478 in rental income, while the taxpayers reported only $28,653.
General Business Credit: On their 2012 return, the taxpayers claimed a Section 38 rehabilitation credit of $99,800 on Form 3800/3468 in connection with K Lofts.

The taxpayers filed all relevant returns late and, following an examination that included a bank deposit analysis for 2012, 2013, and 2014, the Commissioner issued a Notice of Deficiency.

Taxpayers’ Request for Relief

Before the Tax Court, the taxpayers sought a redetermination of the deficiencies, arguing that:

The bank deposit analyses were arbitrary and failed to distinguish between taxable and nontaxable deposits, specifically disputing a $40,000 due diligence expense advance from a friend, Connie DeMerell.
The 2013 sales of K Lofts units resulted in a long-term capital loss of approximately $125,000 based on a per-unit adjusted basis of $25,000, rather than the taxable capital gain determined by the Commissioner.
The third-party payments were fully deductible as ordinary and necessary business expenses of RRA under Section 162(a).
The $811,000 in cash transfers to MSL and K Lofts were deductible as business expenses under Section 162(a), unreimbursed partnership expenses, or worthless bad debts under Section 166.
The $50,000 farmland payment was deductible as business rent under Section 162(a)(3).
The disallowance of their $27,215 interest deduction, $9,825 in rental income, and $99,800 general business credit was erroneous.
The additions to tax and accuracy-related penalties were inapplicable due to reasonable cause.

The Court’s Analysis: Burdens of Proof and Production

As an initial matter, the Court established the procedural framework governing tax controversies. Generally, the Commissioner’s deficiency determinations are presumed correct, and the taxpayer bears the burden of proving them erroneous under Rule 142(a) and Welch v. Helvering, 290 U.S. 111, 115 (1933) (citing also Merkel v. Commissioner, 192 F.3d 844, 852 (9th Cir. 1999)).

However, in cases involving unreported income in the Ninth Circuit (to which this case was appealable), the general presumption is subject to a minimal threshold. For the presumption to apply, “the Commissioner must base the deficiency on some substantive evidence that the taxpayer received unreported income” under Hardy v. Commissioner, 181 F.3d 1002, 1004 (9th Cir. 1999) and Weimerskirch v. Commissioner, 596 F.2d 358, 361 (9th Cir. 1979) (citing also Caldwell v. Commissioner, T.C. Memo. 2022-51). Once the Commissioner introduces some substantive evidence of unreported income, the burden shifts to the taxpayer to prove by a preponderance of the evidence that the deficiency is arbitrary or erroneous.

Crucially, the Court distinguished this rule from the burden of proving entitlement to deductions, which remains unconditionally on the taxpayer. As the Supreme Court held in INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992), “the taxpayer bears the burden of proving entitlement to any deduction claimed”. Under Section 6001 and Treasury Regulation § 1.6001-1(a), taxpayers are required to maintain records sufficient to enable the Commissioner to determine the correct tax liability (citing Hradesky v. Commissioner, 65 T.C. 87, 89–90 (1975)).

Finally, under Section 7491(c), the Commissioner bears the burden of production regarding additions to tax and penalties, meaning he must “come forward with evidence sufficient to show that it is appropriate to impose the penalty” under Higbee v. Commissioner, 116 T.C. 438, 446 (2001). Once met, the taxpayer bears the burden of proving that the penalty is incorrect or that a valid defense applies.

Ordinary Income Adjustments: Application of the Law to the Facts

The Court applied these principles to each ordinary income adjustment made by the Commissioner:

Gross Receipts from RRA’s Real Estate Business

The Court held that the Commissioner’s bank deposit analyses for 2012, 2013, and 2014 established the requisite “some substantive evidence” of unreported income. It is long-established that “a bank deposit is prima facie evidence of income and [the Commissioner] need not prove a likely source of that income” under Tokarski v. Commissioner, 87 T.C. 74, 77 (1986) (citing Clayton v. Commissioner, 102 T.C. 632, 645–46 (1994) and Alioto v. Commissioner, T.C. Memo. 2025-125). Under the bank deposits method, the Commissioner assumes all deposits represent taxable income, but must account for known nontaxable sources (citing DiLeo v. Commissioner, 96 T.C. 858, 868 (1991)). The Court dismissed the taxpayers’ argument that the bank deposit analyses did not distinguish between taxable and nontaxable deposits, finding that the analyses explicitly separated “Non-Taxable Deposits,” “Taxable Deposits,” and “Transfers”.

However, the taxpayers met their burden regarding a $40,000 bank deposit in 2014. Mr. Reed credibly testified that his friend, Connie DeMerell, transferred $40,000 as an advance for expenses he would incur in performing due diligence on a commercial property in Baton Rouge, Louisiana. The Court concluded that “the $40,000 transfer from Ms. DeMerell was an advance and thus should not be included in the Reeds’ income”. Because the taxpayers failed to establish that any of the other deposits were nontaxable, the Court sustained the remaining gross receipts deficiencies.

Gross Receipts from the Wood-Selling Business

For the tax years 2014 and 2015, the parties stipulated that Green Star made bank deposits related to Mr. Reed’s wood sales totaling $32,981 and $5,200, respectively, which satisfied the Commissioner’s burden under Tokarski. The taxpayers argued they failed to report the 2015 gross receipts because they did not receive a Form 1099 from Green Star. The Court rejected this excuse as a matter of law: “The failure to receive tax information forms . . . does not excuse a taxpayer from his obligation to report income” under Section 61 and Reyes Barrios v. Commissioner, T.C. Memo. 2026-32, at *4 (citing also Brunsman v. Commissioner, T.C. Memo. 2003-291). Thus, the wood-selling gross receipts adjustments were sustained.

Rental Income

The Court sustained the Commissioner’s adjustment of $9,825 in unreported rental income for the 2014 tax year. The Commissioner established his burden of production by introducing Dixon Ventures’ Form 1099-MISC. Because the taxpayers failed to address the rental income in their post-trial briefs, the Court held they had abandoned the issue: “If an argument is not pursued on brief, we may conclude that it has been abandoned” under Mendes v. Commissioner, 121 T.C. 308, 312–13 (2003) and Nicklaus v. Commissioner, 117 T.C. 117, 120 n.4 (2001) (citing also Miller v. Fairchild Indus., Inc., 797 F.2d 727, 738 (9th Cir. 1986)).

Taxable Interest Income

The Commissioner determined the taxpayers had unreported interest income of $21,146 for 2015, supported by a Schedule K-1 from TJ Tower reflecting $21,065 in taxable interest issued to Mr. Reed’s disregarded entity. The Court disallowed the unsupported $81 difference, but sustained the $21,065. The taxpayers argued that because they did not personally receive the interest, it could not constitute taxable income. The Court dismissed this argument as a fundamental misunderstanding of subchapter K: “A partner’s gross income includes his distributive share of partnership gross income” under Sections 61(a)(13), 702, and 704. Under Treasury Regulation § 301.7701-2(a), the disregarded entity status of Mr. Reed’s LLC does not shield the income. Therefore, “partners are taxable on their distributive or proportionate shares of current partnership income irrespective of whether that income is actually distributed to them” under United States v. Basye, 410 U.S. 441, 447–48 (1973) (citing also Vecchio v. Commissioner, 103 T.C. 170, 185 (1994)).

Capital Gains and the Substantiation of Partnership Basis

The taxpayers challenged the Commissioner’s determination that they underreported net capital gains by $92,190 in 2013, which included a sustained long-term capital gain of $108,526 from the sale of K Lofts units. Under Section 741, gain or loss on the sale of a partnership interest is characterized as capital gain or loss, measured by the difference between the amount realized and the adjusted basis under Section 705 (citing Pollack v. Commissioner, 69 T.C. 142, 144 (1977)). The amount realized includes any reduction in the partner’s share of partnership liabilities under Section 752 and Treasury Regulation § 1.752-1(h).

Mr. Reed testified that his cumulative adjusted basis across 45 units of K Lofts was $1.2 million, yielding an approximate per-unit basis of $25,000. He attempted to prove this by pointing to K Lofts’ 2013 Schedule K-1, which reflected capital contributions of $533,016, distributions of $99,696, and ending partnership liabilities of $298,791. The Court calculated that even if all these values were included in basis, the per-unit basis would be only $16,085 ($723,811 total basis / 45 units). At a sale price of $17,000 per unit, Mr. Reed would still recognize a taxable gain rather than a loss.

More significantly, the Court highlighted that the K Lofts Schedule K-1 is a year-end document and does not reflect the temporal order of contributions, distributions, and liability adjustments. Because the unit sales occurred before or during April 2013, and K Lofts did not borrow its $1.375 million loan from IBERIABANK until May 31, 2013, Mr. Reed’s share of that liability could not increase his basis at the time of the sales. Under Treasury Regulation § 1.705-1(a)(1), adjusted basis must be determined as of the exact date of the sale. Pointing out the “uncertainty in the record as to when and how Mr. Reed’s basis in his K Lofts units increased or decreased,” the Court held the taxpayers failed to establish error, sustaining the $108,526 capital gain. The Court refused to apply the Cohan estimation doctrine (Cohan v. Commissioner, 39 F.2d 540, 543–44 (2d Cir. 1930)), concluding that “to allow the Cohan doctrine to be invoked by the taxpayers would be in essence to condone the use of that doctrine as a substitute for the burden of proof” under Coloman v. Commissioner, 540 F.2d 427, 431–32 (9th Cir. 1976).

Conversely, the Court rejected the Commissioner’s post-trial argument that Mr. Reed realized an increased short-term capital gain of $196,950. Because this new theory would increase the deficiency, the Commissioner bore the burden of proof under Rule 142(a) and Dynamo Holdings Ltd. Partnership v. Commissioner, 150 T.C. 224, 237–38 (2018) (citing also Ware v. Commissioner, 92 T.C. 1267, 1268 (1989)). The Commissioner failed to prove Mr. Reed’s beginning basis or when he acquired the units, failing to establish short-term status. Thus, only the capital gain determined in the Notice of Deficiency was sustained.

Expense Deductions and the Third-Party Expense Trilogy

The Tax Court broke the taxpayers’ substantial RRA Schedule C third-party deductions into three categories, arriving at distinct legal conclusions for each:

Allowed Advisor and Consultant Payments (Appendix A)

The Court allowed $32,593 (2012), $85,667 (2013), $99,731 (2014), and $76,733 (2015) in deductions for payments made to land use consultants, engineering firms, drafting services, and legal advisors (such as Perkins Coie and Mitchell Williams). These payments represent ordinary and necessary expenses paid or incurred in carrying on RRA’s trade or business under Section 162(a). The Court rejected the Commissioner’s argument that RRA was entitled to reimbursement, as the project entities’ books did not record these payments as loans or reimbursable expenses.

Disallowed Medical Practice and Unexplained Payments (Appendix B)

The Court disallowed $52,705 (2012), $4,800 (2013), $170,912 (2014), and $134 (2015) in claimed business deductions. This category included substantial payments made to set up Dr. Reed’s dermatology practice (RDNW), such as insurance contracting and hospital credentialing consultants. The Court ruled that because RRA was in the business of real estate consulting, payments for a medical practice “have no clear tie” to its trade or business. To the extent these represented startup costs of a separate trade or business, the taxpayers failed to establish when the medical practice commenced active business operations under Root v. Commissioner, T.C. Memo. 2025-51. Other miscellaneous payments were disallowed for lack of basic substantiation.

Disallowed Construction and Repair Payments (Appendix C)

The Court disallowed $38,974 (2012), $256,513 (2013), $34,533 (2014), and $14,685 (2015) in deductions for repairs, construction, and landscaping performed directly at the project sites (MSL and K Lofts). These costs were stipulated to be the responsibility of the project LLCs rather than RRA. Under the general rule, “a taxpayer generally may not deduct the payment of another person’s expenses” under Deputy v. du Pont, 308 U.S. 488, 494–95 (1940) and Welch v. Helvering, 290 U.S. at 114 (citing also Betson v. Commissioner, 802 F.2d 365, 368 (9th Cir. 1986); Dietrick v. Commissioner, 881 F.2d 336, 338 (6th Cir. 1989); Eskimo Pie Corp. v. Commissioner, 4 T.C. 669, 677 (1945)).

The taxpayers attempted to invoke the exception established in Lohrke v. Commissioner, 48 T.C. 679, 688 (1967), which allows a taxpayer to deduct expenses paid on behalf of another entity if: (1) the primary motive is to protect or promote the taxpayer’s own business, and (2) the expenditure is an ordinary and necessary expense of the taxpayer’s business (citing Cooper v. Commissioner, 143 T.C. 194, 213 (2014) and Plano Holding LLC v. Commissioner, T.C. Memo. 2019-140). To establish the first prong, the taxpayer must “demonstrate a direct nexus between the purpose of the payment and the taxpayer’s business or income-producing activities” under Bone v. Commissioner, T.C. Memo. 2001-43 (citing Lettie Pate Whitehead Found., Inc. v. United States, 606 F.2d 534, 538 (5th Cir. 1979)). The Court concluded that RRA failed this first prong because the taxpayers did not show a direct nexus to Mr. Reed’s development fees:

The taxpayers did not establish that the real estate project entities were unable to pay their own construction and repair expenses in 2012 or 2013.
The record contained no written agreements specifying when, how, or under what conditions RRA would be compensated with development fees.
Mr. Reed was an investor in the project entities, meaning his personal stake “casts doubt on the possibility that benefits accruing to the project entities from Reed Realty Advisors’ payments were ‘merely incidental’ to the payments’ true purpose” (citing HIE Holdings, Inc. v. Commissioner, T.C. Memo. 2009-130) (citing also Square D Co. & Subs. v. Commissioner, 121 T.C. 168, 200 (2003) and Hood v. Commissioner, 115 T.C. 172, 181 (2000)).

Cash Transfers to Project Entities: Capital vs. Debt

The taxpayers sought to deduct $811,000 in cash transfers to MSL and K Lofts, claiming they were business expenses, unreimbursed partnership expenses, or bad debts. The Court emphasized the fundamental principle that “while a taxpayer is free to organize his affairs as he chooses, nevertheless, once having done so, he must accept the tax consequences of his choice, whether contemplated or not” under Commissioner v. National Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 149 (1974) and Lomas Santa Fe, Inc. v. Commissioner, 693 F.2d 71, 73 (9th Cir. 1982) (citing also Temnorod v. Commissioner, T.C. Memo. 2025-127). The Court systematically rejected all three of the taxpayers’ arguments:

Trade or Business Expense Deduction

The cash transfers did not represent business expenses under Section 162(a) because they were made from the taxpayers’ personal bank accounts rather than RRA’s accounts, meaning RRA did not “pay or incur” them (citing United States v. Cocke, 399 F.2d 433, 447 (5th Cir. 1968) and Brown v. Commissioner, T.C. Memo. 2017-18). Additionally, Mr. Reed made the transfers in his personal capacity as a guarantor to help the project entities meet bank loan requirements. Furthermore, “an expenditure for which there is an unconditional right of reimbursement is not deductible as a business expense” under Orvis v. Commissioner, 788 F.2d 1406, 1408 (9th Cir. 1986) and Burnett v. Commissioner, 356 F.2d 755, 759–60 (5th Cir. 1966) (citing also Canelo v. Commissioner, 53 T.C. 217, 223–24 (1969); Levy v. Commissioner, 212 F.2d 552, 554–55 (5th Cir. 1954); Glendinning, McLeish & Co. v. Commissioner, 61 F.2d 950, 952 (2d Cir. 1932); Flower v. Commissioner, 61 T.C. 140, 152 (1973)). The project entities recorded almost all of the transfers as loans, and actually repaid portion of those loans in 2014, establishing an active right of reimbursement.

Unreimbursed Partnership Expenses

Under Probandt v. Commissioner, T.C. Memo. 2016-135, “a partner cannot himself deduct the expenses of a partnership, even if he incurred the expenses in furtherance of partnership business”. An exception applies only if a partnership agreement or routine practice requires the partner to pay partnership expenses out of personal funds (citing Klein v. Commissioner, 25 T.C. 1045, 1051–52 (1956)). The operating agreements for MSL and K Lofts contained no such requirement, and personal loan guaranties do not constitute partnership agreements. Additionally, the exception requires payment out of own funds without reimbursement, which the taxpayers failed to prove (citing McLauchlan v. Commissioner, 558 F. App’x 374, 379 (5th Cir. 2014) and Wallendal v. Commissioner, 31 T.C. 1249, 1252 (1959)) (citing also Frazier v. Commissioner, T.C. Memo. 2024-3).

Partially or Wholly Worthless Debts

Under Section 166 and Treasury Regulation § 1.166-9, a guarantor’s payment can give rise to a worthless debt deduction when the underlying debt between the debtor and guarantor becomes worthless, as the guarantor “steps into the creditor’s shoes” under Putnam v. Commissioner, 352 U.S. 82, 85 (1956). “Debts are wholly worthless when there are reasonable grounds for abandoning any hope of repayment in the future, . . . and it could thus be concluded that they have lost their ‘last vestige of value’” under Estate of Mann v. United States, 731 F.2d 267, 276 (5th Cir. 1984) (citing Dallmeyer v. Commissioner, 14 T.C. 1282, 1292 (1950) and Bodzy v. Commissioner, 321 F.2d 331, 335 (5th Cir. 1963)).

Whether a debt is worthless is a question of fact examined under all circumstances (citing Am. Offshore, Inc. v. Commissioner, 97 T.C. 579, 594 (1991) and Boehm v. Commissioner, 326 U.S. 287, 293 (1945)). The Court held that worthlessness was not established because the project entities owned substantial real estate that could be rented or sold. Furthermore, Mr. Reed later exchanged K Lofts units for Deep Creek units (showing continuing value). Taxpayers also failed to seek contribution from solvent co-guarantors (like Wooten Epes). Finally, Section 166(a)(2) partial worthlessness requires a charge-off under Treasury Regulation § 1.166-3(a)(2), which the taxpayers did not perform.

Consequently, the Court concluded: “If the Reeds’ transfers were capital contributions, they are not entitled to deductions for them. If they were loans . . . then the Reeds have not established that they were worthless in the years at issue”.

Farmland Lease and Abandoned Claims

Farmland Lease

The Court allowed a $50,000 deduction for farming rent in 2013 under Section 162(a)(3). Section 162(a)(3) permits a deduction for rental payments required as a condition to the continued use or possession of business property in which the taxpayer has no equity (citing also Treasury Regulation § 1.162-11(a)). The Court credited Mr. Reed’s unrebutted testimony that the $50,000 represented rental payments for 12 months of occupancy rather than a purchase deposit. The Court dismissed the Commissioner’s post-trial argument that the payments exceeded fair market value, emphasizing that “assertions on brief . . . [are] not evidence” under Rule 143(c) and Niedringhaus v. Commissioner, 99 T.C. 202, 214 n.7 (1992).

Interest Expense and General Business Credit

The Court sustained the disallowance of the $27,215 interest deduction for 2015 and the $99,800 rehabilitation credit for 2012. Because the taxpayers failed to address these issues in their post-trial briefs, they were deemed abandoned under the Mendes doctrine. Furthermore, the interest payments lacked substantiation of payment timing or interest rates, and there was no evidence that K Lofts’ building was placed in service in 2012 to trigger the rehabilitation credit under Section 47(b) (citing Consumers Power Co. v. Commissioner, 89 T.C. 710, 723–26 (1987)).

Additions to Tax and Accuracy-Related Penalties

The Court sustained the late-filing additions to tax under Section 6651(a)(1) and the accuracy-related penalties under Section 6662(a):

Failure to File Timely Returns (Section 6651(a)(1))

The Commissioner met his burden of production by introducing certified transcripts and stipulations showing the taxpayers’ returns were filed late (citing Wheeler v. Commissioner, 127 T.C. 200, 207 (2006)). Because the taxpayers abandoned the issue on brief and failed to establish reasonable cause, the additions to tax were sustained.

Substantial Understatement Penalty (Section 6662(a))

The Commissioner asserted a 20% penalty for a substantial understatement of income tax. Under Section 7491(c), the Commissioner met his burden of production by introducing a Civil Penalty Approval Form signed by the agent’s supervisor on November 29, 2016, establishing timely written supervisory approval under Section 6751(b)(1) (citing Laidlaw’s Harley Davidson Sales, Inc. v. Commissioner, 29 F.4th 1066, 1072–74 (9th Cir. 2022) and Kraske v. Commissioner, 161 T.C. 104, 111 (2023)). Rule 155 computations will confirm if the understatement meets the substantial threshold (citing Clay v. Commissioner, 152 T.C. 223, 246 (2019) and George v. Commissioner, T.C. Memo. 2026-10). The taxpayers failed to assert a reasonable cause and good faith defense under Section 6664(c)(1), and the penalty was sustained (citing United States v. Boyle, 469 U.S. 241, 245 (1985) and Cooper v. Commissioner, 877 F.3d at 1095).

Conclusion

The Tax Court’s decision in Reed v. Commissioner reinforces several fundamental principles of federal income tax law. For tax professionals, the primary takeaway is the absolute necessity of strict recordkeeping under Section 6001. Commingling personal and business accounts, failing to maintain complete double-entry general ledgers, and treating disregarded entities as direct extensions of personal finances will routinely prove fatal under audit. Additionally, the case highlights that taxpayers are strictly bound by the chosen legal form of their transactions and cannot retroactively recharacterize capital contributions or loans as ordinary business expenses when their ventures collapse.

Prepared with assistance from Gemini Notebook.