T.C. Memo. 1997-335

UNITED STATES TAX COURT

JOHN JOSEPH MONTANO, Petitioner v. 

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 4283-96. Filed July 24, 1997.

On the facts, Held: R's disallowance of P's 1993 

Schedule C "returns and allowances" in the amount of $45,243

sustained; P's self-employment tax and related deductions 

redetermined; and R's determination that there is an 

accuracy-related penalty due under sec. 6662(a), I.R.C., 

sustained.

John Joseph Montano, pro se.

Roberta D. Repasy, for respondent.
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MEMORANDUM OPINION

NIMS, Judge: Respondent determined a deficiency in

petitioner's Federal income tax for 1993 in the amount of

$11,129, and an accuracy-related penalty under section 6662(a)

for 1993 in the amount of $2,226. All section references are to

sections of the Internal Revenue Code in effect for 1993, and all

Rule references are to the Tax Court Rules of Practice and

Procedure. 

There are two issues for decision. The first is whether

petitioner is entitled to reduce Schedule C gross receipts or

sales by claimed returns and allowances in the amount of $45,243. 

(Respondent's disallowance of this amount resulted in a selfemployment tax liability and a corresponding deduction of onehalf the amount thereof, both of which are reflected in the

$11,129 income tax deficiency determined by respondent, but which

must be recomputed in accordance with discussion infra.) The

second issue for decision is whether petitioner is liable for the

accuracy-related penalty under section 6662(a).

Some of the facts were stipulated and are so found. 

Petitioner resided in Corona Del Mar, California, at the time he

filed his petition. 
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In the early 1970s petitioner was engaged in manufacturing

and selling filament tape and pressure-sensitive labels. In the

late 1970s, petitioner obtained a contract with the General

Services Administration (GSA) under which he sold approximately

$600,000 worth of filament tape to the Federal Government. The

contract was canceled by GSA because the tape failed to meet

contract specifications, and the defective tape was returned to

petitioner. Thereafter, petitioner no longer manufactured

filament tape and did not purchase any additional products for

resale. 

Petitioner stored the defective tape in a shed in his wife's

backyard. Petitioner was married in 1949, but he and his wife

have lived apart for at least 20 years. Since 1979, petitioner

has attempted to sell the tape, which petitioner describes as

"about $500,000 worth of material", but without success. 

Petitioner owed the Small Business Administration (SBA) $500,000

on a loan made in connection with his efforts in the filament

tape business, and the SBA confiscated petitioner's equipment and

other business assets in the early 1980s to cover some of the

loans it had made to petitioner. 
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In 1992, petitioner placed 115,375 rolls of filament tape on

consignment with Advanced Coating. In this connection, on August

26, 1992, petitioner issued an invoice to Advanced Coating

showing the sale price of the tape as $80,762.50 for 115,375

rolls of filament tape, at 70 cents per roll. On his 1992

return, petitioner reported no income from the consignment to

Advanced Coating. 

In 1993, Advanced Coating returned all of this tape as

defective. On May 12, 1993, petitioner gave Advanced Coating a

credit memo for $45,243 indicating that approximately 64,633

rolls had been returned. On his 1993 return petitioner claimed

$45,243 in returns and allowances in connection with the returned

tape previously consigned to Advanced Coatings. Since Advanced

Coating could use none of the tape, the invoice and credit memo,

taken together, reflect a substantial discrepancy in the amount

of tape consigned and the amount returned. Petitioner explained

this discrepancy as "Well, only because it was just a book entry. 

It didn't really make any difference." 

Petitioner paid no Federal income tax for the years 1991

through 1994. The following table reflects petitioner's wage
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income and claimed losses relating to his filament tape

endeavors:

 Sch. C

 Sch. C Cost of 

 Wage Sch. C Returns & Goods Sold/ Sch. C

Year Income Gross Rec. Allowances Expenses1 Loss

1991 $38,468 $ 4,297 $37,683 - 0 - ($33,386)

1992 37,192 12,162 29,478 $19,330 ( 36,646)

1993 38,204 6,417 45,243 6,031 ( 32,795)

1994 41,989 9,273 23,172 22,637 ( 36,536)

_______________

1 For the 1992 and 1993 years this figure represents only

the amounts claimed as cost of goods sold. No expenses were

claimed on the Schedules C attached to these returns. The figure

for the 1994 tax year comprises $20,527 for cost of goods sold

and $2,110 in expenses.

Petitioner testified that from time to time over a number of

years he attempted to dispose of his defective tape inventory. 

He testified that "so what I went through this whole period of

time was trying to get somebody who would take some of it, any of

it or all of it". But since the record is rather muddied, it is

not clear that petitioner actually ever sold any of the tape.

Petitioner does not attempt to explain how Schedule C

returns and allowances could exceed Schedule C gross receipts,

particularly in each year over a 4-year period as reflected on

the above table. Throughout 1993 and for 5 years before that,

petitioner was employed by the State of California as a payroll
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tax auditor. We are convinced that in order to offset his State

of California wage income, petitioner merely manipulated

fictitious figures on his Federal income tax returns, including

1993, to make it appear that he was operating a Schedule C

business that generated losses year after year. Petitioner

admitted as much at trial. Accordingly, we sustain respondent's

disallowance of petitioner's claimed returns and allowances on

Schedule C of his 1993 return in the amount of $45,243.

Petitioner's 1993 Schedule C reflects that petitioner

operated a business of filament tape manufacturer and converter

as a proprietor. The Schedule C shows gross receipts of $6,417,

returns and allowances of $45,243, and cost of goods sold of

$6,031. Respondent disallowed the returns and allowances, but

made no adjustment to cost of goods sold. 

In computing petitioner's total earnings from selfemployment, respondent erroneously added the $6,031 cost of goods

sold to the gross receipts of $6,417, rather than reducing the

latter by the former, thus erroneously arriving at total earnings

from self-employment in the amount of $12,448. Based on this

figure, respondent incorrectly computed petitioner's selfemployment tax liability and the related self-employment tax
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deduction. The correct amounts will be recomputed under Rule

155.

As noted, respondent determined an accuracy-related penalty

under section 6662(a) in the amount of $2,226. Section 6662(a)

imposes an accuracy-related penalty of 20 percent on any portion

of an underpayment of tax that is attributable to items set forth

in section 6662(b). Section 6662(b)(1) provides that section

6662(a) is to apply to any portion of an underpayment

attributable to negligence or disregard of rules or regulations. 

Section 6662(b)(2) applies section 6662(a) to any substantial

understatement of income tax.

Section 6662(c) defines negligence to include any failure to

make a reasonable attempt to comply with the provisions of the

Internal Revenue Code, and defines "disregard" to include any

careless, reckless, or intentional disregard of rules or

regulations. Petitioner was an accountant who knew that he was

not entitled to reduce his gross receipts by returns and

allowances when he had not taken the sales price of the returned

items into his income. Thus, we find and hold that petitioner

demonstrated negligence or disregard of rules or regulations. 

There is a substantial understatement of income tax if the
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amount of the understatement exceeds the greater of 10 percent of

the tax required to be shown on the return for the taxable year,

or $5,000. Sec. 6662(d)(1)(A).

Under section 6662(d)(2), the term "understatement" means

the excess of the amount of tax required to be shown on the

return over the amount of tax shown on the return, reduced by any

rebate (within the meaning of section 6211(b)(2)). The

computation of the correct amount of the section 6662(a) penalty

will be made under Rule 155. 

To reflect the foregoing,

Decision will be entered

under Rule 155.