TAX COURT OPINION

Case: Samuel T. & Carol A. Seawright
Docket Number: 1796-00
Judge: Thornton
Opinion Type: reported
Filed: 12/18/2001
Pages: 10

117 T.C. No. 24 UNITED STATES TAX COURT SAMUEL T. SEAWRIGHT AND CAROL A. SEAWRIGHT, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket No. 1796-00. Filed December 18, 2001. R's examination of Ps' tax liability commenced no later than July 16, 1998. After Ps petitioned this Court informally contacted potential third-party witnesses without providing advance notice to Ps. to redetermine the deficiency, R's trial counsel 1. Held: Sec. 7602(c), I.R.C., which requires . that R give the taxpayer advance notice of third-party contacts regarding R's examination or collection activities, examination activities here, which all occurred before the Jan. 19, 1999, effective date of sec. 7602(c). is inapplicable with respect to R's 2. Held, further, sec. 7602(c), I.R.C., is inapplicable with respect activities. to R's trial preparation 3. Held, further, sec. 7602(e), I.R.C., which . . restricts R's use of financial status or economic reality examination techniques, respect employed before the July 22, 1998, effective date of sec. 7602(e), to R's examination techniques which were is inapplicable with I.R.C.. 4. Held, further, Ps bear the burden of proof. SERVED D C - 3 - FINDINGS OF FACT The parties have stipulated some of the facts, which we incorporate herein by this reference. Petitioners Petitioners are married. When they filed their petition, they resided in Columbia, South Carolina. Columbia North East Used Parts Petitioner Samuel T. Seawright (Samuel) owned and operated a family business known as Columbia North East Used Parts (Columbia), located on Hardscrabble Road in Columbia, South Carolina. Samuel was the primary laborer for Columbia, petitioner Carol Seawright (Carol) was the record-keeper, and petitioners' son, Monty Seawright (Monty), worked with Samuel at Columbia on weekends. Columbia began operations in 1977, when Samuel paid about $2,000 for five junked cars. Petitioners owned a 1978 Ford truck with a wrecker boom in the bed. Samuel used the truck to pick up and haul away items such as appliances, scrap metal, and junked vehicles. Samuel did not charge for the hauling service. Petitioners stored the junked vehicles and other hauled-away items at their scrap yard on Hardscrabble Road. Samuel rebuilt some of the junked vehicles to sell. Petitioners salvaged and sold used parts from some of the junked vehicles. - 5 - Revenue and Taxation, Division of Motor Vehicles (DMV) an "Owner's/Rebuilder's Affidavit", certifying, among other things, the fair market value of each rebuilt vehicle, as estimated in the National Automobile Dealers Association (NADA) Official Used Car Guide (blue book).3 Four of these affidavits were filed in 1995. On these affidavits, Samuel certified NADA estimated fair market values for four of the rebuilt vehicles in amounts totaling $32,100.4 Petitioners' Federal Income Tax Returns Carol prepared petitioners' 1994 and 1995 joint Federal income tax returns. On the Schedule C, Profit or Loss From Business (Sole Proprietorship) (Schedule C), attached to their 1994 return, petitioners reported that Columbia had $500 gross receipts and zero cost of goods, showing no opening inventory, no purchases, and no ending inventory. For 1994, petitioners reported that Columbia had a net loss of $3,486. On the Schedule C attached to their 1995 return, petitioners reported that Columbia had $20,852 in gross receipts, cost of 3 Petitioners did not have a car dealer's license. In order the six rebuilt vehicles, Columbia North East Used Parts first transferred title to petitioners' son, Monty (Monty), to sell (Columbia) Seawright application for certificates of title/registration with the South Carolina Department of Revenue and Taxation, Division of Motor Vehicles (DMV). for no consideration. Monty then made 4 The two remaining affidavits were filed in March and April 1996. values of On these affidavits, Samuel certified fair market the other two rebuilt vehicles totaling $9,925. Expense item on return Amount allowed Adiustment Amount claimed Car & truck Depreciation Employee benefit program Insurance Office expenses Other rent Supplies Taxes & licenses Mortgage Utilities Totals -- -- $1,106 844 514 2,781 2,450 1,776 879 646 $10,996 $467 856 -- -- 154 -- -- 1,024 879 404 $3,784 $(467) (856) 1,106 844 361 2,781 2,450 751 - 242 $7,212 . Respondent also disallowed petitioners' claimed cost of goods sold in its entirety on the grounds that petitioners had failed to substantiate the amount of purchases and had failed to establish the value of Columbia's opening and closing inventories for taxable year 1995. Respondent made no adjustment to the amount of Columbia's 1995 gross receipts as reported by petitioners. On February 15, 2000, petitioners filed their petition with this Court. On March 27, 2000, respondent filed his answer, requesting that his determination as set forth in the notice of deficiency be in all respects approved. On October 2, 2000, the trial was held in Columbia, South Carolina. - 9 - Section 7602(c) is effective for contacts made after the 180th day after the July 22, 1998, enactment of RRA 1998 (i.e., after January 18, 1999). See RRA 1998 sec. 3417(b), 112 Stat. 758. Alleged Third-Party Contacts During the Examination On brief, petitioners allege that during the initial July 16, 1998, meeting, Leary told Carol that she had previously contacted petitioners' bank and that Leary subsequently asked Carol why petitioners changed banks so often. Petitioners allege that this line of inquiry "shows that she [Leary] had extensive third party contacts". Petitioners allege that they told Leary that they wanted to be notified whenever a third party was contacted, but they never received any third-party contact information from the Internal Revenue Service (IRS). . Section 7602(c) has no application to any third-party contacts that might have been made by respondent's agents before the January 19, 1999, effective date. The evidence does not show that Leary or any other of respondent's agents made any third- party contacts after January 18, 1999, in the course of the examination that culminated in the January 6, 2000, issuance of the notice of deficiency. Alleged Third-Party Contacts During Trial Preparation On brief, petitioners allege that shortly before the October 2000 trial date, respondent's agents contacted various third - 11 - The pertinent legislative history states that the purpose of section 7602(c) is to require "the IRS to notify the taxpayer before contacting third parties regarding examination or collection activities (including summonses) with respect to the taxpayer." S. Rept. 105-174, at 77 (1998), 1998-3 C.B. 537, 613 (emphasis added). Accordingly, we conclude that Congress did not intend section 7.602(c) to apply to third-party contacts made by the IRS in the course of trial preparation activities, where those contacts are not with respect to examination or collection activities.3 This interpretation is consistent with the general statutory scheme, which distinguishes between the litigation of tax liabilities, see chapter 76 (captioned "Judicial Proceedings"), 5 We.are mindful that under sec. 6212(c), the Internal in the course of making the IRS is not barred from exercising See United States (7th Cir. 1986) (pending Tax Court in certain circumstances, determine financial records, where the taxpayers' Revenue Service (IRS), may, an additional deficiency after the taxpayer files a timely petition with the Tax Court, and that such further determination, its examination authority under sec. 7602(a). v. Gimbel, 782 F.2d 89, 93 proceedings did not bar IRS from invoking summons authority, rather than using Tax Court discovery procedures, taxpayers' still subject Bolich v. Rubel, Commissioner may apply to the Board [of Tax Appeals) the assessment prepare his case in advance by a further examination, which is quite another matter from producing evidence in support of it."). The instant case does not present, and we do not reach,- the issue of apply with respect determine an additional deficiency pursuant during the pendency of a Tax Court proceeding. to examinations conducted by the IRS to to sec. 6212(c) [in the notice of deficiency], he may need to the extent to which the restrictions of sec. 7602(c) might to redetermination pursuant to sec. 6212(c)); 67 F.2d 894, 895 (2d Cir. 1933 )("Since the in seeking the liability was to increase does not restrict that authority. - 13 - As far as the record reveals, respondent's examination activities ceased no later than January 6, 2000, when respondent issued the notice of deficiency. Respondent has not sought to use the section 7602(a) examination power to determine any additional deficiency, pursuant to section 6212(c). There is no evidence that respondent used the section 7602(a) examination • power to summon prospective third-party witnesses and take testimony under oath. Cf. Westreco, Inc. v. Commissioner, T.C. . Memo. 1990-501, modified in Ash v. Commissioner, 96 T.C. 459 (1991). There is no evidence to suggest that respondent's agents . made any third-party contacts in connection with any collection activity.7 We conclude that the informal contacts of potential witnesses by respondent's trial counsel in preparation for trial were not made in the course of respondent's examination or collection activities and therefore are not subject to the restrictions of section 7602(c). 6(...continued) be submitted to the Court and to petitioners at before the trial session. Respondent complied with these requirements of the standing pretrial order. least 15 days As a general matter, if the taxpayer has filed a petition the IRS with this Court for a redetermination of the deficiency, may not commence collection activities until this Court's decision has become final. Sec. 6213(a). - 15 - Under Rule 142, the burden of proof is upon the petitioner, except as otherwise provided by statute. In certain . circumstances, if the taxpayer introduces credible evidence with respect to any factual issue relevant to ascertaining the proper tax liability, section 7491 places the burden of proof on respondent. Sec. 7491(a); Rule 142(a)(2). Section 7491 is effective with respect to court proceedings arising in connection with examinations commencing after July 22, 1998. RRA 1998 sec. 3001(c)(2), 112 Stat. 726. The undisputed facts indicate that respondent's examination of petitioners' 1995 Federal income tax return commenced before July 23, 1998. Accordingly, section 7491 has no application to this case. Petitioners bear the burden of proof. Rule 142(a). Petitioners' Trade or Business Expenses The parties disagree about petitioners' entitlement to deduct, pursuant to section 162, various trade or business expenses. Vehicle Expenses On their 1995 return, petitioners claimed no deduction for vehicle expenses. In the notice of deficiency, respondent allowed petitioners a deduction of $467. Petitioners have not established that they are entitled to a vehicle expense deduction greater than respondent has allowed. - 17 - Petitioner-s Aave not estäblished that ~thëy áre entcitled rtt rany deduction fót "Other rent". Supplies ' On their 1995 return, petitioners claimed a $2, 450 deduction for suppliés-, all of which respondent disällowed in the notice of defidièncy. On- brief, -reäpondent concedes that petitioners incurrëd $2, 450 in expenses for materials used-Lto rebuild7 vehicles bùt rcontends that this amount shbuld be added to purchases in computirig petitioners'' cost of goods solti, rather than deducted as a current expense. We agree with respondent. The evïdence iri the record indicates2that tfie cl·aimed sup~pÝies expenses rel5ate to petitioners' rebuilding¯ junked automobiles for sale and ttiat 'these expertses represerfted either raw materdålécor sWpplies entering into the rebuilt automobi-1·es or direct labor relating thereto. These amountss are. inclúdatble in the cost of petitioners' rebuilt automobilés, see. sec.: ?1.471- 3(c), SIndóilie tax Regs., and thus are not deductible as trade. or busihëss experise pursu-ant to s@ction 162 (a) but ïrather enter ihto the ca®lcul~ation of petitioners' cost of goods sold in . determ?ining their grbss income, see Beatty v. Commissioner, 106 T. C. 268, 273 (1996) . Small Tools Petitioriers contend that théy are - entitled. to a $281 deduction for smáll tools. Whì%e small tools with a useftil life - 21 - Columbia's ending inventory for 1995 consisted of whatever no-cost items remained from its 1995 opening inventory, plus the items purchased for $18,742 (including 14 junked vehicles) plus the $2,450 expended on supplies (as previously discussed). Thus, Columbia's ending inventory had a cost of $21,192. Petitioners contend that the market value of Columbia's 1995 ending inventory was only $1,500, which they argue was the scrap • value of the 1995 ending inventory. Petitioners have failed to substantiate their claimed market value "by providing evidence of actual offerings, actual sales, or actual contract cancellations." Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 535 (1979). In any event, petitioners' contention is contradicted by Samuel's admissions in the Owner's/Rebuilder's Affidavits filed with the DMV in 1995, certifying that the NADA estimated fair market values of just four of the rebuilt automobiles in Columbia's inventory totaled $32,100.¹° Petitioners' contention is further undermined by evidence showing that these four rebuilt automobiles, along with another vehicle ¹° Although Columbia transferred title to the rebuilt vehicles to Monty for no consideration before the vehicles were sold to third parties, Samuel testified that Monty were not gifts, stating: were put them were reported as income through our business." Consequently, we ignore petitioners' automobiles to Monty. in his [Monty's] name in order to sell it [sic]. All of "The fact is that transfers of the rebuilt the transfers to these vehicles