Tax Court in Brief | Sprouse v. Comm’r | Unreported Income, Substantiation, and a Section 6673 Penalty
Sprouse v. Commissioner, T.C. Memo. 2026-80 | September 2, 2026 | Greaves, J. | Docket No. 17017-23
Short Summary
A Texas consultant earned $481,110 in wages in 2019, collected $275,161 in rental income and $40,200 in nonemployee compensation, and reported total income of $1. During the audit he filed an amended return that reported the wages and then deducted them, describing the offset on the form as “LAWFUL MONEY 12 USC 411.”
The IRS determined a deficiency of $217,478 and an accuracy-related penalty of $43,496. Judge Greaves sustained both, disallowed the unsubstantiated Schedule E deductions, and added a $2,500 penalty under section 6673(a) for maintaining the proceeding primarily for delay.
Key Issues
Did the Commissioner establish the evidentiary foundation for unreported income? What does a taxpayer have to produce to sustain claimed mortgage interest and depreciation deductions on rental property? And what conduct pushes a case from unsubstantiated into sanctionable?
Primary Holdings
The petitioner received and must pay tax on the wages, nonemployee compensation, and rental income determined in the notice. He failed to substantiate mortgage interest beyond the amounts reported on Forms 1098 and failed to substantiate any depreciation. The section 6662(a) penalty applies, and supervisory approval under section 6751(b) was timely obtained. He must pay a $2,500 penalty under section 6673(a).
Key Points of Law
In an unreported income case, the Commissioner must first introduce an evidentiary foundation connecting the taxpayer to the income-producing activity. He had a Form W-2 from the consulting firm, a Form 1099-MISC from a second payor, the taxpayer’s own amended return reporting the rents, and the taxpayer’s admission at trial that he worked and was paid. Statements on a return are admissions the Court may rely on absent persuasive evidence to the contrary.
The title 12 argument didn’t survive the footnote. Section 411 of title 12 concerns the issuance and redemption of Federal Reserve notes. It does not let a taxpayer exclude wages or claim a deduction equal to compensation received for services. The petitioner never developed the theory before the Court, and Judge Greaves treated it as abandoned.
Deductions are a matter of legislative grace, and the taxpayer must show both that the deduction is allowable and that the expense was paid or incurred. On mortgage interest, third-party Forms 1098 established $73,564, and the Commissioner allowed that amount in full. The petitioner claimed $216,753 and did not produce anything for the difference.
The depreciation ruling is the one worth flagging for anyone with rental property. To claim depreciation, a taxpayer must establish the property’s depreciable basis, the recovery period, and the method used to compute it. He introduced no records for any of the three, and when questioned at trial, he could not explain how he calculated the $88,360 figure. That is what an unsubstantiated depreciation deduction looks like, and the Commissioner’s disallowance was sustained without much discussion.
On penalties, a substantial understatement is one exceeding the greater of 10% of the tax required to be shown or $5,000, and a $217,478 understatement clears both. The Commissioner met his burden of production and showed section 6751(b) supervisory approval dated January 24, 2023, ahead of the July 30, 2023, notice of deficiency—timely, because the notice was the first communication of the penalty. The reasonable cause defense failed on the record: a return reporting $1 of income, an amended return deducting an entire year’s wages on a theory found nowhere in the Code, and no substantiation for the rest.
Section 6673(a)(1) authorizes a penalty up to $25,000 where a taxpayer instituted or maintained proceedings primarily for delay, took a frivolous or groundless position, or unreasonably failed to pursue administrative remedies. The Court has considerable latitude in deciding whether to impose one and how much.
Judge Greaves was careful about the line. Lack of substantiation alone does not warrant a section 6673 penalty. What did, however, was the aggregate: a “Notice of Discovery Demand” requesting birth certificates for the clerk of court, the judge, and Justice Department staff; a motion asking the opposing party to establish the “Identity, Standing, and Capacity of the Accused”; a post-trial filing purporting to rescind his signature on his own amended return, signed as “A LIVING MAN STANDING IN PRIVATE CAPACITY”; and mailings to IRS employees accusing them of crimes and enclosing photocopied dictionary definitions of “fraud.”
There was also a candor problem. The Commissioner sought a continuance in May 2024 because the petitioner refused to hold a Branerton conference until he obtained counsel. The Court granted it, and granted a second one in December 2024 on the same understanding. In his third continuance motion, the petitioner said his search for counsel began in August 2025.
Insight
Two items worth noting. The first is the depreciation holding, which has nothing to do with protest arguments. Basis, recovery period, method—a taxpayer who cannot produce those three items at trial will likely lose the deduction, and it does not matter how obviously real the building is. Rental-property owners lose depreciation on exactly this record more often than they lose it on a legal question.
The second is the anatomy of the sanction. Judge Greaves separated substantiation failures from delay, and he built the section 6673 finding out of specific filings and a specific misrepresentation about the search for counsel. Frivolous filings are one problem. Telling the Court something that turns out not to be true is a different and worse one.
The Court also warned that a future appearance advancing frivolous positions may draw a larger penalty.
Our primer on IRS penalties covers the accuracy-related and delay penalties in more detail, and Freeman Law’s IRS penalty defense attorneys handle these disputes. Prior weeks are collected at The Tax Court in Brief, and the full opinion is available from CourtListener.
The information contained in this post is general in nature, is provided for informational and educational purposes only, and does not constitute legal advice or create an attorney-client relationship. The law is fact-specific and subject to change. Consult qualified counsel regarding your particular circumstances.
