NICK KIKALOS and HELEN KIKALOS v. Commissioner of Internal Revenue

In the
United States Court of Appeals
For the Seventh Circuit
____________
No. 04-2981
N ICK K IKALOS and H ELEN K IKALOS ,
Petitioners-Appellants,
v.
C OMMISSIONER OF I NTERNAL R EVENUE ,
Respondent-Appellee.
____________
Appeal from the United States Tax Court.
No. 11486-01—Joel Gerber, Judge.
____________
A RGUED A PRIL 7, 2005—D ECIDED J ANUARY 19, 2006
____________
Before M ANION, R OVNER and S YKES , Circuit Judges.
R OVNER , Circuit Judge. The Internal Revenue Service
audited the 1997 tax return of Nick and Helen Kikalos
and found that they underreported their income and thus
owed more tax than they had paid. The IRS also as-
sessed an accuracy-related penalty against the pair in the
amount equal to twenty percent of the underpayment.
The couple petitioned the United States Tax Court for a
redetermination of the deficiency and after a two-day
hearing, the court sustained both the deficiency and the
penalty. Nick and Helen Kikalos appeal and we affirm.

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2 No. 04-2981
1 We will refer to the four stores collectively as “Nick’s Liquor.”
2 For the remainder of the opinion, when we refer to “Kikalos”
in the singular, we are referring to Nick Kikalos, Sr.
I.
In 1997, the tax year at issue, Nick and Helen Kikalos
owned four liquor stores in Hammond, Indiana. The
stores, operating under the name “Nick’s Liquor Mart,” sold
beer, wine, liquor and cigarettes, among other things. 1
These family-run ventures were sole proprietorships, with
daughter Elizabeth managing one of the stores. Elizabeth
and her brother, Nick Jr., together owned a fifth store
called “Nick’s Cigarette City.” At the time of this audit,
Nick and Helen Kikalos (we will call them the taxpayers for
shorthand) were no strangers to the IRS, having been
audited every year from 1986 through 1993. A recurring
theme in these audits had been the IRS’s displeasure
with the taxpayers’ record-keeping. In 1995, at the conclu-
sion of the audits for tax years 1990, 1991 and 1992, the
IRS and the taxpayers executed an “Agreement to Maintain
Adequate Books and Records,” which specified cer-
tain records for the taxpayers to keep in the future. The
agreed-upon records included daily cash register tapes
and daily cash reconciliations. The daily cash reconcilia-
tions were to include the amount of cash which was with-
drawn from the business for whatever purpose, the amount
of cash available for bank deposits, and a record of the
amount, date and type of draw being withdrawn from the
business. The 1997 audit was triggered in part when the
Mercantile National Bank contacted the IRS to re-
port unusual financial activity by Nick Kikalos. 2 Kikalos
had purchased thirty-one cashier’s checks from the Mercan-
tile National Bank in 1997 in an amount total-
ing $809,734.51. Kikalos used cash and third-party
checks to purchase the checks.

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No. 04-2981 3
The audit ultimately focused on the cigarette aspect of the
taxpayers’ stores. Nick’s Liquor participated in cigarette
company programs called “buydowns.” A buydown is a
discount a cigarette manufacturer provides to a retail outlet
for each pack or carton of cigarettes sold during a certain
time period. The manufacturers give the discount directly
to the retailer with the expectation that the retailer will
then pass on the savings to the ultimate consumer. There
are no coupons involved in buydown programs. Rather, the
cashier at the point of sale must be aware of the buydown
programs for particular brands of cigarettes and ring up the
sale accordingly. At Nick’s Liquor, the store managers were
responsible for informing the cashiers about the cigarette
brands on buydown at any particular time. Some cigarette
companies attempted to verify that retailers were passing
the discounts on to their customers by checking the prices
displayed in the retailers’ windows. Manufacturers also
asked retailers to take inventory at the beginning and
end of a buydown period to verify the amount of buydown
reimbursement a retailer should receive. Nick’s Liquor
conducted its own inventories that were not audited or
verified by the cigarette companies.
After the close of a buydown period, Nick’s Liquor
would submit a request for reimbursement to the manu-
facturer sponsoring the program, and the manufacturer
would then issue a check based on the number of cartons
purchased during the buydown period multiplied by the
discount per carton. The delay between the request for
reimbursement and issuance of a check would sometimes be
as long as two months. Because of this delay, some checks
received in early 1997 were due to sales made in 1996 and
some payments for 1997 buydown sales were not received
until early 1998. In addition to buydowns, Nick’s Liquor
honored manufacturers’ paper coupons. Cigarette compa-
nies reimbursed Nick’s Liquor for the face value of submit-
ted coupons plus postage costs. For the sake of simplicity,

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4 No. 04-2981
we will use the term “buydown” to include both buydown
and coupon income, unless otherwise indicated.
According to the IRS, Nick’s Liquor received substan-
tial payments from cigarette companies in 1997 that were
not deposited to the stores’ business bank accounts, were
not reported to the stores’ accountant and consequently
were not disclosed on the couple’s 1997 tax return. Instead
of recording this income through normal channels, Kikalos
took more than $500,000 worth of buydown reimburse-
ment checks, combined them with other third party
checks and used them to purchase more than $800,000
worth of cashier’s checks from the Mercantile National
Bank. After the bank contacted the IRS, a revenue agent
commenced an audit and attempted to determine whether
these cashier’s checks represented unreported income. The
taxpayers and their accountant provided a number of
records to the revenue agent, including spreadsheets that
purported to document cigarette buydown income. The
spreadsheets contained many different and conflicting
numbers for this type of income so the revenue agent
selected the largest figure given in any spreadsheet,
$777,848, and used that as the baseline figure for buy-
down income. The taxpayers had reported $653,164 of
buydown income on their 1997 return, leading the reve-
nue agent to conclude that the taxpayers had underreported
their income by $124,684. The agent issued a deficiency
notice for the amount of tax due on this additional income,
and also imposed an accuracy-related penalty equal to
twenty percent of the underpayment pursuant to 26
U.S.C. § 6662(a).
The taxpayers petitioned the Tax Court for a redeter-
mination of the deficiency. After a two-day hearing, the
court determined that the taxpayers had in fact under-
reported their income by $242,666, nearly twice the
agent’s determination. The court therefore upheld the IRS’s
deficiency notice as well as the penalty. In reaching this

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No. 04-2981 5
result, the court took a different evidentiary path than the
revenue agent. The court noted that three of the four
spreadsheets provided by the taxpayers reflected $521,695
in buydown income but the fourth indicated $777,848. The
court found that, despite requests from the revenue agent,
the taxpayers failed to furnish adequate records to substan-
tiate the amount of buydown income recorded by each of the
four stores on a daily, monthly or annual basis. Nor did the
taxpayers provide records to reconcile cigarette company
reimbursement payments with the amounts reported as
buydown income. The court noted the unusual purchase of
thirty-one cashier’s checks, which Kikalos accomplished by
using buydown reimbursement checks, other third-party
checks, and cash in amounts less than $10,000 to avoid IRS
reporting requirements. Kikalos did not tell his accountant
about these cashier’s checks and he did not record the
receipt of the third party checks in the accounting records
for Nick’s Liquors. All in all, Kikalos converted $531,605 of
buydown reimbursement checks into cashier’s checks. The
court remarked that Kikalos admitted in his testimony that
one of his objectives in purchasing the cashier’s checks with
third-party checks rather than cash was to avoid reporting
cash transactions exceeding $10,000 to the IRS. The court
found significant the taxpayers’ failure to demonstrate that
the third-party checks used to purchase the cashier’s checks
were included in gross business income. Moreover, the
accountant for Nick’s Liquor testified that she was unaware
of the existence of the cashier’s checks. The accountant
verified that the only entry in the 1997 for cigarette
company checks was the $400,746 entry in October. She
could not recall what documentation she was given to
support this entry but said, “I would imagine it was checks.”
Tr. at 236. She said the basis for the amount of the entry
was “[p]robably a deposit appearing in the bank, but I
couldn’t say for sure.” Id. She then clarified that although
she could not recall the documentation exactly, she believed
it was a deposit slip. Id. The taxpayers did not produce

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6 No. 04-2981
credible evidence that the cigarette company checks used to
purchase the cashier’s checks were part of this October
1997 entry.
From these facts, the court concluded that Kikalos had
not reported $531,605 in buydown checks that had been
used to purchase cashier’s checks. The accountant for Nick’s
Liquor had noted $400,746 in buydown income in the
October 1997 records for the stores. The court added those
two figures for a total of $932,352. The court then adjusted
to exclude 1996 buydown income that was received in 1997
(a $73,392 subtraction), and to include 1997 income that
was not received until 1998 (a $100,810 addition). The IRS
conceded that it had double-counted $63,940 in “rack and
promotional” income from cigarette companies, so the court
excluded that amount as well. All in all, the court calcu-
lated $895,830 in buydown income. Kikalos and his wife
reported $653,164 in buydown income on their 1997 tax
return, and the court concluded that unreported buydown
income equaled $242,666. Although this figure was nearly
double the amount originally claimed by the IRS, the
government did not seek an increased deficiency. Because
Kikalos did not have adequate records to challenge this
calculation, the court upheld the original deficiency. The
court also upheld the accuracy-related penalties imposed by
the IRS under section 6662. That section allows a 20%
penalty on any understatement of tax attributable to
negligence or disregard of the rules and regulations, or any
substantial understatement of income tax. The court found
that Kikalos violated this section when he failed to keep
adequate books or records after repeatedly being warned by
the IRS to do so. The court again noted Kikalos’s testimony
that his practice of purchasing cashier’s checks was de-
signed in part to conceal large cash transactions from the
government. These two factors justified the accuracy-
related penalty, according to the court. The taxpayers
appeal.

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No. 04-2981 7
3 Although the number quoted in the taxpayers’ brief differs
slightly from the amount found by the Tax Court, the difference
does not affect the outcome of the appeal. In the end, the govern-
ment did not seek to recover taxes on the amount proved at the
hearing but limited its claim to the amount stated in the original
deficiency notice.
II.
On appeal, Kikalos and his wife raise three issues. First,
they assert that the Tax Court impermissibly allowed
the IRS to introduce a new theory of unreported income
in its post-trial brief. Second, they contend that the Tax
Court then clearly erred in accepting that post-trial theory
that the couple received $890,055 3 in buydown income
in 1997. Finally, the taxpayers maintain that the Tax Court
clearly erred in imposing a negligence penalty against
them. In reviewing decisions of the Tax Court, we assess
questions of law de novo, and review factual determinations
for clear error. Estate of Kunze v. Commissioner, 233 F.3d
948, 950 (7th Cir. 2000); Kikalos v. Commissioner, 190 F.3d
791, 793 (7th Cir. 1999). Moreover, we review applications
of law to the facts for clear error. Kunze, 233 F.3d at 948;
Kikalos, 190 F.3d at 793; Pittman v. Commissioner, 100
F.3d 1308, 1312-13 (7th Cir. 1996). We will reverse findings
of fact for clear error only when, on reviewing the entire
record, we are left with the definite and firm conviction that
a mistake has been committed. Pittman, 100 F.3d at 1313.
A.
The taxpayers complain that the Tax Court improperly
allowed the IRS to change its theory and method of proof in
its post-trial brief and then embraced this new theory in its
decision. According to the taxpayers, the government’s
original theory was that a spreadsheet produced by the
taxpayer showed $777,848 in buydown income but their

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8 No. 04-2981
1997 tax return reported only $653,164 of buydown income,
a difference of some $124,684. In its post-trial brief, the
government suggested a different method of calculating the
shortage, this time noting that the taxpayers’ accountant
recorded $400,746 in buydown income in October 1997, and
bank records showed that Kikalos had purchased cashier’s
checks using $531,605 in buydown checks. Because the
accountant testified she was unaware of the purchase of the
cashier’s checks and because Kikalos did not produce
sufficient records to demonstrate that he had reported any
of that $531,605 on his 1997 return, the government urged
the Tax Court to add these figures together for a baseline of
buydown income. After adjustments, and after subtracting
the amount of buydown income the taxpayers did report on
their 1997 return, the Tax Court adopted this new cal-
culation and found that they underreported buydown
income in the amount of $242,666. Because this amount
was nearly double the shortage the IRS sought to prove, the
Tax Court upheld the deficiency notice. The taxpayers urge
us to find that this change in the calculation of the shortage
constituted “a whole new method of proof and theory” that
came too late in the proceedings. The taxpayers assert that
because the IRS raised these “new positions” in amended
pleadings, the burden of proof, normally borne by the
taxpayers-petitioners at this stage of the proceedings,
should have been shifted to the IRS. The taxpayers also
maintain that allowing these new theories so late in the
case prejudiced them and constituted reversible error.
Deficiencies determined by the Commissioner of Inter-
nal Revenue are presumed to be correct and the taxpayer
bears the burden of proving otherwise. Tax Court Rule
142(a); Reynolds v. Commissioner, 296 F.3d 607, 612 (7th
Cir. 2002); Pittman, 100 F.3d at 1313; Zuhone v. Commis-
sioner, 883 F.2d 1317, 1323 (7th Cir. 1989). However, Tax
Court Rule 142 also specifies that with respect to “any new
matter, increases in deficiency, and affirmative defenses,
pleaded in the answer” the burden of proof is on the

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No. 04-2981 9
Commissioner. Tax Court Rule 142(a); Friedman v. Com-
missioner, 216 F.3d 537, 543 (6th Cir. 2000). The govern-
ment did not seek an increase in the deficiency and affirma-
tive defenses are not at issue; thus the only dispute is
whether the IRS raised a “new matter” in its post-trial brief
when it suggested a different calculation for the buydown
income shortage. This is not a close call. The change in the
method of calculation of the buydown income is not a “new
matter.” A new position taken by the IRS Commissioner is
not a “new matter” if it “merely clarifies or develops [the]
Commissioner’s original determination without requiring
the presentation of different evidence, being inconsistent
with [the] Commissioner’s original determination, or
increasing the amount of the deficiency.” Friedman, 216
F.3d at 543. See also Estate of Kanter v. Commissioner, 337
F.3d 833, 851 (7th Cir. 2003), rev’d on other grounds, 125 S.
Ct. 1270 (2005).
In Kanter, we stated:
The Commissioner is allowed the latitude to amend his
pleadings and even adopt entirely new theories support-
ing assessed deficiencies without triggering Rule 142’s
shift in burden, so long as the new theory is not incon-
sistent with the original allegation, does not require
new evidence in its support, nor increases the amount
of the deficiency.
Kanter, 337 F.3d at 851 (emphasis in original). The original
deficiency notice specified that the taxpayers failed to
report “coupon buy downs” in the amount of $124,684. R. 1,
Ex. A-1. Another exhibit in the deficiency notice further
detailed the shortage in a paragraph entitled “Statement
Regarding Adjustment for Coupon Buy Downs":
It is determined that all coupon income was not in-
cluded in gross income. Coupon income shown on each
store’s general ledger data input sheet was totaled and
compared to checks received and to your accountant’s

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10 No. 04-2981
summary of total coupon money. This comparison
revealed additional income of $124,684.00 and an
adjustment is made accordingly.
R. 1, Ex. A-4. The calculation raised in the post-trial brief
and largely adopted by the Tax Court was completely
consistent with the original deficiency notice. Both the
notice and the post-trial brief sought to document unre-
ported coupon and buydown income and both noted the
difference between the accountant’s records and the
buydown reimbursement checks received. No new evidence
was required to conduct this new calculation. Finally,
although the new calculation demonstrated an even greater
shortage than the deficiency notice specified, the govern-
ment agreed to limit its recovery to the amount detailed in
the original deficiency notice. The taxpayers were clearly on
notice that the IRS was examining buydown income in
general and the difference between income reported to their
accountant and total checks received. Because this was not
a new matter, the burden remained on the taxpayers to
demonstrate that the Commissioner’s deficiency determina-
tion was incorrect.
B.
Now that we have determined that the burden was on the
taxpayers to demonstrate error in the deficiency determina-
tion, we turn to whether the taxpayers met this burden.
According to the taxpayers, the theory adopted by the Tax
Court relies on factors not supported by the evidence. In
particular, the taxpayers claim that the court erroneously
assumed they had a secret bank account, and also wrongly
assumed that there was no overlap between the $400,746 in
buydown income recorded by their accountant on October
31, 1997, and the $531,606 in buydown checks that Kikalos
used to purchase cashier’s checks. The taxpayers complain
that the Tax Court erroneously manipulated the evidence

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No. 04-2981 11
regarding transactions near the end of the prior year and
the beginning of the subsequent year. Much of the taxpay-
ers’ brief is devoted to attacks on the methodology and
credibility of the revenue agent who conducted the audit.
Aside from the fact that nothing in the record undermines
the credibility of the agent, we need not address these
arguments because the Tax Court did not, in the end, rely
on the agent’s original calculations in upholding the
deficiency. We will therefore address only those arguments
that relate to the Tax Court’s ultimate determination.
As we noted earlier, deficiencies determined by the
Commissioner are presumed to be correct and the tax-
payer bears the burden of proving otherwise. Tax Court
Rule 142(a); Reynolds, 296 F.3d at 612; Pittman, 100 F.3d
at 1313; Zuhone, 883 F.2d at 1323. The IRS explained that
buydown income was recorded in the monthly general
ledgers for Nick’s Liquors under an accounting category
titled “Cigarette Company Checks.” The accountant for
Nick’s Liquors made a single entry in the books for this
account in 1997, an October 31 entry for $400,746. The
IRS noted that Nick’s Liquors received a substantial
number of reimbursement checks from cigarette com-
panies before and after that date in 1997, and that these
checks were not deposited to the stores’ business bank
account and were not reported to the stores’ accountant.
Moreover, Kikalos converted more than $500,000 worth of
cigarette company reimbursement checks into cashier’s
checks without ever telling the stores’ accountant about the
receipt of the reimbursement checks. The court therefore
added together the amount listed in the accountant’s ledger
and the amount used to purchase cashier’s checks. Using
the approximately two-month delay between the time of
cigarette sales and receipt of a reimbursement check, the
court adjusted this amount to exclude payments received in
1997 for 1996 sales and to include payments for 1997 not
received until 1998. The court further reduced the total by

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12 No. 04-2981
$63,940 because the evidence showed that this amount had
already been included in another category of cigarette
company income for promotional payments. The resulting
amount, $895,830, exceeded the amount reported on the
1997 tax return by $242,666.
This amount more than justified the Tax Court’s deci-
sion to uphold the deficiency notice in the amount of
$124,684. The IRS points out that the taxpayers have
produced no records to demonstrate the claimed overlap
between the $400,746 accounting entry and the $531,605
used to purchase cashier’s checks. During cross-examina-
tion by Ronald Jordan, District Counsel for the IRS, Kikalos
testified that he purposely tried to avoid the attention of the
IRS when he purchased the cashier’s checks with third-
party checks:
Mr. Jordan: You didn’t take the check to the store,
you took cash to the store and gave the
store cash for the check.
Mr. Kikalos: That is correct.
Mr. Jordan: My question to you is why did you go
through this process, why didn’t you just
take the check to the store, let them ring
the check up and deposit the check with
their daily receipts?
Mr. Kikalos: I wouldn’t have been able to use the
check to purchase certified checks.
Mr. Jordan: Why didn’t you just take the cash that
you had that you could have given to the
store and purchase the cashier’s check?
Mr. Kikalos: Because I was afraid of the IRS. If you
take $10,000, you have to fill out a what-
do-you-call? I’m buying $50,000 checks,
not in cash but I mean—

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No. 04-2981 13
4 He produced two days’ worth of cash register tapes from one
of the four stores to demonstrate that discounts were made at
the time of the sale. According to the taxpayers, the register tapes
for 1997 were approximately forty-six miles long and there was
“no point in submitting this mountain of paper as it could not
disprove the basic premise underlying the government’s position:
that appellants were cheating customers and cigarette manufac-
turers.” Petitioners-Appellants’ Reply Brief, at 10.
Mr. Jordan: You were afraid that the IRS would find
out about your purchase of cashier’s
checks?
Mr. Kikalos: They’ve been known to talk to me a few
times.
Tr. at 207. Kikalos then explained that he did not keep
records of the buydown checks he received because the
checks did not represent income. Rather, they were reim-
bursements for discounts given to the consumer at the point
of sale, a complete pass-through with no income to the
stores. Tr. at 208. Kikalos, however, did not produce at the
hearing the daily cash register tapes that would have
demonstrated that the store actually passed the discounts
onto the consumers and recorded the transaction at the
point of sale. 4 The taxpayers seem to be under the impres-
sion that it was the burden of the IRS to examine the daily
register tapes to verify Kikalos’ version of the stores’
accounting practices. The taxpayers also maintain that the
IRS was obliged to demonstrate that the there was no
overlap between the buydown checks recorded by the stores’
accountant in October 1997 and the buydown checks that
Kikalos used to purchase cashier’s checks.
It is difficult to parse through Kikalos’ theory given the
state of the record. The hearing raised many questions
for which Kikalos provided no answers. For example,
Kikalos did not consider buydown reimbursements to be

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14 No. 04-2981
income but the accountant for Nick’s Liquors recorded
$400,746 of buydown income in the stores’ ledger in October
1997. Kikalos himself reported $653,164 in buydown income
on his 1997 tax return, which is puzzling if none of the
buydown checks should have been included in gross income.
We are also left to wonder why Kikalos did not tell his
accountant about more than $500,000 in reimbursement
checks, information she certainly needed to reconcile the
stores’ books. And finally, we question why Kikalos con-
verted so many of the buydown checks to cashier’s checks
without his accountant’s knowledge and in a manner he
specifically designed to avoid the attention of the IRS. As
we stated above, the Commissioner’s determination of the
amount of unreported buydown income is presumptively
correct and the taxpayers have the burden of proving
otherwise. Pittman, 100 F.3d at 1313; Zuhone, 883 F.2d at
1323. “As long as the procedures used and the evidence
relied upon by the government to determine the assessment
had a rational foundation, the inquiry focuses on the merits
of the tax liability, not on IRS procedures.” Pittman, 100
F.3d at 1313. To rebut the presumption of correctness and
shift the burden to the Commissioner, the taxpayers must
demonstrate that the Commissioner’s deficiency assessment
lacks a rational foundation or is arbitrary and excessive.
Pittman, 100 F.3d at 1313. “All that is required to support
the presumption is that the Commissioner’s determination
have some minimal factual predicate.” Pittman, 100 F.3d at
1317. The Commissioner easily meets the standard here.
The Commissioner demonstrated that the taxpayer’s
accountant recorded $400,746 in buydown income in
October 1997, that the taxpayer purchased cashier’s checks
using more than $500,000 in buydown reimbursement
checks, that no records show an overlap between these two
amounts and that the taxpayers avoided giving their
accountant full information about these reimbursement
checks while seeking also to avoid the attention of the IRS.
Moreover, the IRS presented evidence supporting the

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No. 04-2981 15
adjustments made for the typical eight-week delay involved
in processing requests for buydown reimbursement. That is
a sufficient and rational factual basis for the government’s
deficiency calculation. See Zuhone, 883 F.2d at 1326 (“The
Commissioner may use any reasonable method of calcula-
tion where, as in this case, the taxpayer fails to produce or
maintain adequate records from which actual income may
be ascertained.”) Kikalos has not produced evidence to show
that there was an overlap as he argues on appeal, or that
the reimbursement checks were not income at all because
the discounts were passed on to consumers at the point
of sale as shown in daily register tapes. See Lerch v.
Commissioner, 877 F.2d 624, 631 (7th Cir. 1989) (the
determination of whether a specific item of income was
reported on a given tax return is a fact question; the
taxpayer bears the burden of proving in Tax Court that
an item of income has been included in a tax return).
Kikalos produced two register tapes and gave testimony
and other evidence that the Tax Court simply did not
believe. See Frierdich v. Commissioner, 925 F.2d 180, 185
(7th Cir. 1991) (the statements of an interested party as
to his own intentions are not necessarily conclusive even
when they are uncontradicted). We see no reason to rebut
the presumption of correctness granted to the Commis-
sioner in these circumstances. There is no clear error in the
Tax Court’s determination regarding the existence or the
amount of the deficiency. See Reynolds, 296 F.3d at 613. We
t h e r e f o r e u p h o l d t h e C o m m i s s i o n e r ’ s d e -
ficiency determination and affirm the ruling of the Tax
Court.
C.
The last issue is the propriety of the penalty that the IRS
imposed on Kikalos and his wife under 26 U.S.C. § 6662(a).
Section 6662(a) provides that a twenty percent penalty is

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16 No. 04-2981
imposed on any underpayment of tax attributable to, among
other things, the taxpayer’s negligence or disregard of the
rules and regulations, or any substantial understatement of
tax. Section 6662(c) defines negligence to include failure to
make a reasonable attempt to comply with the Internal
Revenue Code. The term “disregard” includes “any careless,
reckless, or intentional disregard.” 26 U.S.C. § 6662(c). In
its deficiency notice, the IRS stated that it had determined
that the entire underpayment of taxes in this case was
attributable to negligence or disregard of the rules and
regulations of the Internal Revenue Code and thus the IRS
imposed a twenty percent penalty on the amount owed.
Pursuant to Section 7491(c), the Commissioner bears the
burden of production in any court proceeding with respect
to liability for any penalties imposed. 26 U.S.C. § 7491(c).
The Tax Court found that the Commissioner met that
burden by demonstrating that the taxpayers failed to keep
adequate books and records to substantiate the items in
questions. See Reynolds, 296 F.3d at 618 (negligence
includes any failure by the taxpayer to keep adequate books
and records). According to the Tax Court, Kikalos failed to
maintain adequate records even though he had been
repeatedly warned by the IRS to do so. The Tax Court noted
that it had previously found the taxpayers’ records inade-
quate for 1990, 1991 and 1992. In June 1995, the taxpayers
signed a record retention agreement with the IRS. The Tax
Court found that even in light of this history, Kikalos failed
to maintain adequate records relating to buydown income.
The Court also found significant Kikalos’ testimony that his
practice of purchasing cashier’s checks was designed in part
to conceal large cash transactions from the IRS. The Tax
Court therefore upheld the accuracy-related twenty percent
penalty.
“[A] finding of negligence under § 6662 is a finding of fact
that we review for clear error.” Reynolds, 296 F.3d at 618.
Moreover, determinations of negligence by the Commis-

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No. 04-2981 17
sioner are presumed to be correct; the taxpayers bear the
burden of proving that the penalties are erroneous. Id. The
taxpayers maintain that they did keep adequate records but
that the IRS agent refused to review them. They argue that
the prior cases relating to other tax years are irrelevant to
the present deficiency determination because buydown
income had never before been an issue with the IRS and
they had no expectation that the IRS would question these
transactions. Kikalos contends that, despite his limited
education, he maintained all the records the IRS asked him
to keep to the best of his ability. He contests the Tax
Court’s reliance on his purchase of cashier’s checks because
he voluntarily produced all records of the check purchases
after obtaining them from the bank at his own expense.
Each of these arguments is more specious than the last
and none demonstrates clear error on the part of the Tax
Court. The taxpayers had every opportunity at their
hearing to produce records that supported their claims
about buydown reimbursements. They produced less than
one percent of the cash register tapes that they claim would
have shown that buydowns were simply discounts passed
directly on to consumers with no income to the stores. They
failed to produce records demonstrating that they had
already accounted in their business records for the buydown
reimbursement checks that Kikalos converted to cashier’s
checks. They had to pay the bank to reconstruct the records
of their cashier’s check purchases only because they did not
keep the original records. Although Kikalos may have had
a limited education, he managed to run four profitable
stores and hired an accountant to keep his records. Perhaps
the boldest argument is that the taxpayers had no reason
to expect that their handling of buydown transactions
would be questioned by the IRS and therefore did not keep
better records. The taxpayers’ own accountant had no idea
that Kikalos was using buydown reimbursement checks to
purchase cashier’s checks and Kikalos himself testified that

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18 No. 04-2981
he engaged in this practice to avoid the attention of the
IRS. Kikalos had every reason to expect that the IRS would
someday ask for documentation for business transactions
that involved hundreds of thousands of dollars. There
was no clear error in the Tax Court’s decision to uphold the
accuracy-related penalty.
III.
For the reasons stated above, we therefore affirm in its
entirety the decision of the Tax Court.
A FFIRMED .
A true Copy:
Teste:
________________________________
Clerk of the United States Court of
Appeals for the Seventh Circuit
USCA-02-C-0072—1-19-06

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