A daycare owner tried to claim extra business deductions but couldn’t back them up. She’s still on the hook for a late-filing penalty in 2017 and accuracy-related penalties for 2016 through 2018. The exact numbers will be crunched later.
Holding
The Tax Court sided with the IRS and tossed out the rest of the disputed Schedule C deductions. It also said the late-filing penalty for 2017 and accuracy-related penalties for all three years stand. The final bill will be calculated under Rule 155, after factoring in whatever the parties already agreed on.
Why it matters
The decision applies settled substantiation rules. Operating a business and producing receipts do not automatically entitle a taxpayer to every claimed expense. Taxpayers must connect their evidence to the specific deductions they seek. Newton could not explain which receipts supported the disputed amounts.
Additional records produced during litigation secured IRS concessions. After reviewing documents Newton supplied at the calendar call, the IRS allowed several expenses. The dispute concerned deductions beyond those allowances. The opinion therefore distinguishes expenses the IRS accepted from additional claims Newton failed to prove.
Negligence independently supported the accuracy-related penalties. Inadequate records established negligence after the IRS demonstrated supervisory approval. The alternative substantial-understatement ground remained contingent on the final computations. The Court did not need that alternative ground to sustain penalty liability.
The holding has specific limits. The opinion expressly carries no precedential effect in other cases. It resolves an evidentiary failure and penalty liability on this record. It does not establish a new substantive restriction on daycare business expenses, and it does not fix the final tax or penalty amounts.
Key facts
Newton operated a daycare service at two locations. The business provided subsidized childcare to low-income families and received most of its income from Pennsylvania.
Her original 2016 return reported $15,000 of daycare gross receipts and no expenses. She later amended that return to report $318,969 of gross receipts and $303,968 of expenses.
For 2017, Newton reported $273,836 of gross receipts and $282,881 of expenses. For 2018, she reported $263,688 of gross receipts and the same amount of expenses.
Newton filed both the 2017 and 2018 returns on May 13, 2019. An extension made the 2018 return timely. She did not file an extension for 2017, so that return was late.
During examination, the IRS analyzed deposits into seven bank accounts. Its analysis identified gross receipts of:
$609,868.03 for 2016.
$642,291.43 for 2017.
$738,590.33 for 2018.
The September 29, 2021 notice of deficiency determined income tax deficiencies of $133,746, $139,567, and $204,329 for 2016, 2017, and 2018, respectively. Those figures preceded the concessions and final computations.
The IRS allowed expenses Newton substantiated during examination. It allowed additional deductions at trial after reviewing records she produced at the October 5, 2026 calendar call. Those additional allowances included $47,400 of rental expense for each year, several other 2016 expenses, and $12,887 of repair and maintenance expense for 2018.
After concessions, the disputed deduction claims were:
2017: $16,800 for travel; $20,000 for meals and entertainment; and $22,524 for wages misclassified as contract labor.
2018: $3,112 for travel; $21,414 for meals and entertainment; $23,661 for office expenses; and $55,684 for rent or lease of vehicles, equipment, or other business property.
The remaining penalty issues included the 2017 late-filing addition and accuracy-related penalties for all three years.
Judge Joseph W. Nega tried the case on October 7, 2026, and delivered the bench opinion on October 14. The Court served the transmitting order and opinion on October 19.
Statutory and regulatory framework
Business expenses and records. Section 162 permits deductions for ordinary and necessary business expenses. An ordinary expense is normal, usual, or customary in the business; a necessary expense is appropriate or helpful. Section 262 generally bars personal, living, and family expenses. Section 6001 and Treasury Regulation section 1.6001-1 require sufficient supporting records.
Proof of deductions. Rule 142(a) generally places the burden of proof on the taxpayer. Section 7491(a) permits a shift under specified conditions, including substantiation, recordkeeping, and cooperation. The Court resolved this case on the preponderance of the evidence, so allocation of the burden did not control the result.
Late filing. Section 6651(a)(1) imposes an additional tax for an untimely return unless the taxpayer establishes reasonable cause and an absence of willful neglect.
Accuracy-related penalties. Section 6662 imposes a 20% penalty on underpayments attributable to negligence, disregard of rules or regulations, or substantial understatement. For an individual, an understatement is substantial if it exceeds the greater of 10% of the required tax or $5,000. Inadequate books and records can establish negligence.
Penalty proof and approval. Section 7491(c) places the burden of production for the accuracy-related penalty on the IRS. Section 6751(b)(1) requires personal written supervisory approval of the initial penalty determination. The opinion also recognizes a reasonable-cause and good-faith defense.
Arguments
Taxpayer argued:
Newton sought additional deductions for the travel, meals and entertainment, wages, office expenses, and rental or lease expenses that remained disputed.
She offered receipts and testimony concerning the daycare’s expenses, including costs associated with its subsidized meal program.
She testified that she paid $100,000 in cash for food in each year.
In addressing the accuracy-related penalties, she testified about her dedication to her work.
Government argued:
Newton had not substantiated deductions beyond those the IRS had already allowed.
Her untimely 2017 return supported the late-filing addition.
Negligence or substantial understatements supported accuracy-related penalties for 2016, 2017, and 2018.
A civil penalty approval form established the required supervisory approval.
Court’s reasoning
The evidence resolved the deduction dispute. The Court reviewed the ordinary burden-of-proof rules but concluded that the result did not depend on which party carried that burden. It decided the issues from the preponderance of the evidence in the record.
Newton did not connect her receipts to her claims. She produced an assortment of receipts but appeared unable to identify the amount of a deduction she sought to substantiate or explain how particular receipts supported it. The Court applied the established requirement that a taxpayer use the evidence to demonstrate entitlement to a deduction. Submitting unorganized receipts did not satisfy that requirement.
The meal-expense testimony lacked credibility. The Court rejected Newton’s testimony that she spent $100,000 in cash on food each year. Her explanation appeared to begin with payments from Pennsylvania and then derive grocery, labor, and transportation expenses from those payments. The Court viewed that approach as rationalizing her state billings rather than accurately reconstructing her records. Her acknowledgment that the state had not audited the program during the years at issue further diminished the reliability of that testimony.
The remaining expense claims lacked useful supporting evidence. Newton failed to establish entitlement to deductions beyond those the IRS had already allowed. The Court therefore sustained the disallowance of all remaining disputed Schedule C deductions. It resolved those claims on the adequacy of the evidence rather than by issuing separate substantive rulings on each expense category.
Newton established no reasonable cause for the late return. She conceded that she filed her 2017 return late and offered no evidence demonstrating reasonable cause. The Court upheld liability under section 6651(a)(1).
The IRS established approval and negligence. A civil penalty approval form established supervisory approval. Newton’s recordkeeping failures established negligence or disregard under section 6662(b)(1). Her testimony about dedication to the daycare did not establish reasonable cause sufficient to excuse the accuracy-related penalties.
The alternative substantial-understatement ground required computation. Rule 155 computations would determine whether the understatements exceeded the statutory threshold. Negligence already supplied an independent basis for the penalties. Treasury Regulation section 1.6662-2(c) permits only one accuracy-related penalty on a given portion of an underpayment, even when multiple grounds apply.
Result
Bottom line: the court backed the IRS on the disputed deductions, said the late-filing and accuracy penalties stick, and told everyone to go do the final math.
List of citations
I.R.C. §§ 162 and 262(a): Govern ordinary and necessary business expenses and generally exclude personal expenses.
I.R.C. § 6001; Treas. Reg. § 1.6001-1(a), (e): Require sufficient supporting records.
Tax Court Rule 142(a); I.R.C. § 7491(a): Address the burden of proof and conditions for shifting it.
I.R.C. § 6651(a)(1): Governs the late-filing addition and reasonable-cause exception.
I.R.C. § 6662(a), (b)(1), (b)(2), and (d)(1)(A): Establish the accuracy-related penalty and relevant grounds.
Treas. Reg. § 1.6662-3(b)(1), (2): Defines negligence and disregard, including inadequate recordkeeping.
Treas. Reg. § 1.6662-2(c): Prevents multiple accuracy-related penalties on the same portion of an underpayment.
I.R.C. §§ 7491(c) and 6751(b)(1): Address the IRS’s penalty burden of production and written supervisory approval.
I.R.C. § 7459(b); Tax Court Rules 152 and 155: Address oral findings and opinions, service of the transcript, and computation of the decision.
Welch v. Helvering, 290 U.S. 111, 115 (1933): Supports the general presumption of correctness of deficiency determinations.
Deputy v. Du Pont, 308 U.S. 488, 493, 495 (1940); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934): Address entitlement to deductions and ordinary business expenses.
Dagres v. Commissioner, 136 T.C. 263, 279 (2011): Supports resolving issues from the evidence when burden allocation does not affect the outcome.
Commissioner v. Heininger, 320 U.S. 467, 471 (1943): Addresses ordinary and necessary business expenses.
Hale v. Commissioner, T.C. Memo. 2010-229; Patterson v. Commissioner, T.C. Memo. 1979-362: Supports the requirement to explain how records establish claimed deductions.
United States v. Boyle, 469 U.S. 241, 245 (1985): Addresses reasonable cause and willful neglect for late filing.
Chai v. Commissioner, 851 F.3d 190, 221 (2d Cir. 2017); Fumo v. Commissioner, T.C. Memo. 2025-97: Supports the supervisory-approval requirement discussed in the opinion.
Higbee v. Commissioner, 116 T.C. 438, 446–447 (2001): Addresses penalty burdens and the reasonable-cause and good-faith defense.