TAX COURT OPINION

Case: Tibor George Sardy & Kathleen Ann Sardy
Docket Number: 12573-17S
Judge: Panuthos
Opinion Type: bench
Filed: 04/05/2018
Pages: 10

UNITED STATES TAX COURT WASHINGTON, DC 20217 TIBOR GEORGE SARDY & KATHLEEN ) ) ANN SARDY, ) ) ) Docket No. 12573-17S. ) ) ) ) COMMISSIONER OF INTERNAL REVENUE, Respondent Petitioners v. ORDER Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it is ORDERED that the Clerk of the Court shall transmit herewith to petitioners and to respondent a copy of the pages of the transcript of the trial in the above case before Special Trial Judge Peter J. Panuthos at San Francisco, California, on March 20, 2018, containing oral findings of fact and opinion rendered at the trial session at which the case was heard. In accordance with the oral findings of fact and opinion, a decision will be entered under Rule 155. (Signed) Peter J. Panuthos Special Trial Judge Dated: Washington, D.C. April 5, 2018 SEfWED APR -5 2018 Bench Opinion by Special Trial Judge.Peter J. Panuthos 3 'March 20, 2018 Tibor George Sardy .& Kathleen Ann Sardy v. Commissioner of Internal Revenue Docket No. 12573-17S The Court has decided to render oral findings of fact and opinion in this.case and .the following represents the Court's oral findings of fact and opinion. The oral findings of fact and opinion shall not be relied upon as precedent in any other case. This case was heard as.a Small Tax Case pursuant to the provisions of Section 7463 of the Internal Revenue 1 2 3 4 5 6 7 8 9 10 11 12 13 Code in effect when the petition was filed. This bench 14 opinion is made pursuant to the authority granted by 15 16 17 18 19 20 section 7459(b). of the Internal Revenue.Code of 1986, as amended, and Rule 152 of the Tax Court Rules of Practice and Procedure. Section references contained in this bench opinion are to sections of the Internal Revenue Code of 1986, as amended, in effect for 2015, and all Rule references are to the Tax Court Rules of Practice and 21 Procedure. 22 23 By notice of deficiency. dated..March 3, 2.017, the Internal Revenue Service (IRS) determined a deficiency in 24 petitioners' Federal income tax for taxable year 2015 in 25 the amount of $4,029 and that petitioners were liable for 4 a section 6662(a) accuracy-related penalty of $805. The issue to be decided is whether petitioners are entitled to the amount claimed (or some lesser amount) as cost of goods sold on their 2015 Federal income tax return. Some of the facts have been stipulated, and we incorporate the stipulation of facts by this reference. Petitioners resided in California when the petition was timely filed. Since he was seven years old Tibor George Sardy (hereinafter petitioner) was a comic book collector. At the age of 16 he began selling comic books, usually 1 2 3 4 5 6 7 8 9 10 11 12 duplicates from his collection. After some college 13 petitioner worked as a draftsman for a few years. In 1982 14 petitioner, fulfilling a lifetime dream, opened a comic 15 book shop in San Mateo, California. Petitioner was a sole 16 proprietor and business went well for a few years. 17 Petitioner was ord'ering more product from wholesalers 18 19 20 during the 1990s. The spread between petitioner's cost and the retail sales price was approximately 55 cents on the dollar. Thus, petitioner would buy a comic book for 21 45 cents and sell it for $1. In the early 2000s 22 petitioner's sales declined sufficiently so that in 2002 23 24 25 he stopped selling comic books and closed the business. He soon went to work in the facilities department as part of an office support staff. (973)406-2250|operationseescrbers.net|wwwascribers.net For a few years after 2002 petitioner maintained 5 a cubicle in a collective where he could sell some of his remaining comic book inventory. This activity lasted only a few years until the proprietor closed the collective. Petitioner then began to store his comic book inventory in a warehouse in Fremont, California. He later moved the comic books to a storage facility in Burlingame, 1 2 3 4 5 6 7 8 California. In 2010 and years following the rental cost 9 of the storage facility continued to increase and 10 petitioner decided that he needed to unload his remaining 11 comic book inventory and terminate the rental. At this 12 point petitioner had approximately 1,300 boxes of comic 13 14 15 books in st.orage. Each box contained approximately 250 comic books. In 2015 petitioner began a liquidation sale and so d most of the comic books. The boxes of comic 16 books were sold for approximately $15 each. During 2015 17 petitioner did not purchase any additional comic books. 18 19 20 21 22 23 24 25 Petitioners filed a 2015 Form 1040, U.S. Federal Income Tax Return, reflecting reported wages and also attached a Schedule C, Profit or Loss from Business, listing a business name of Tibor Comics for petitioner's comic book sales activity. The Schedule C reflects gross receipts of $24,681 and cost of goods sold of $15,125. The gross income from Tibor Comics was reported as $9,556. The Schedule C also reflected a deduction for other (973)406-2250|operationseescrbers.net|www.escrbers.net 6 1 2 3 4 5 6 7 8 9 10 11 12 bu.siness expenses totaling $26,347, including $22,438 for rental expense, resulting in the net loss of $16,791. Petitioners hired a professional income tax return preparer that they had used for some years to prepare their 2015 Form 1040. In the notice of deficiency the IRS made two adjustments to the Schedule C. The first adjustment disallowed $975 of the $22,438 deduction for rental expense claimed. Petitioners agree that they made an inadvertent error in the calculation of the rental expense and concede this adjustment. The second adjustment was the disallowance of the cost of goods totaling $15,125. 13 Petitioners dispute this adjustment. Respondent asserts 14 15 16 that petitioners failed to substantiate the cost of goods sold for 2015. The notice of deficiency also determined an 17 accuracy-related penalty pursuant to section 6662(a). The 18 parties stipulated a Civil Penalty Approval Form which 19 appears to have been executed by a group manager of the 20 IRS. 21 Burden of Proof 22 23 24 In general, the Commissioner's determination set forth in a notice of deficiency is presumed correct, and the taxpayer bears the burden of proving that the 25 determination is in error. Rule 142(a); Welch v. Cribers (973)406-2250|operationseestrbers.net|www.esobers.net 7 Helvering, 290 U.S. 111, 115 (1933). Pursuant to section 7491(a), the burden of proof as to factual matters .shifts to the Commissioner under certain circumstances. Petitioners did not allege or otherwise show that section 7491(a) applies. See sec. 7491(a)(2) (A) and (B). Therefore, petitioners bear the burden o'f proof. See Rule 142(a). Cost of Goods Sold Section 1.61-3(a), Income Tax Regs., provides that in a manufacturing, merchandising, or mining business, "gross income" means the total sales, less the total cost of goods sold. Cost of goods sold is computed by subtracting the value of ending inventory for a year from the sum of beginning inventory and purchases during the year. Primo Pants Co. v. Commissioner, 78 T.C. 705, 723 (1982). Cost of goods sold is not treated as a deduction from gross income and is not subject to the limitations on deductions set forth in sections 162 and 274. Metra Chem Corp. v. Commissioner, 88 T.C. 654, 661 (1987). Instead, it is subtracted from gross receipts in order to arrive at gross income. Id.; sec. 1.61-3(a), Income Tax Regs. The substantiation rules require a taxpayer to 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 maintain sufficient reliable records which allow the 25 Commissioner to verify the taxpayer's income, cost of (973)406-2250|operationseesertiersnet|www.escrbers.net 8 1 2 3 4 5 6 7 8 9 goods sold, and other expenditures. See sec. 6001; sec. 1.6001-1(a), Income Tax Regs.; Olive v. Commissioner, 139 T.C. 19, 32 (2012), aff'd, 792 F.3d 1146 (9th Cir. 2015). Additionally, the Court may estimate the amount of a deductible expense if a taxpayer establishes that an expense is deductible but is unable to substantiate the precise amount. See Cohan v. Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731, 742-743 (1985). This principle, often referred to as 10 the Cohan rule, also applies to cost of goods sold. See, 11 e.g., Van Dusen v. Commissioner 136 T.C. 515, 537 n.39 12 13 (2011); Goldsmith v. Commissioner, 31 T.C. 56, 62 (1958). We found petitioner to be a credible witness. 14 He provided a clear history of his comic book retail 15 activities and ultimate liquidation of the business in 16 17 2015. Petitioner presented photos which were taken at a later point to illustrate the boxing of the comic books. 18 Petitioner also presented some records which illustrated 19 the method of calculation of gross sales versus cost of 20 goods sold. No evidence was presented which either 21 22 contradicted petitioner's testimony or suggested that his estimate of the costs of the comic books was not reliable. 23 We note that petitioner reported gross sales of the comic 24 25 books amounting to $24,681. Respondent did not question the amount reported as gross sales and petitioner (973)406-2250|operationseerrbersnet|www.escribersnet 9 1 2 3 4 5 apparently substantiated all other expenses except for a small portion of the rental expense which he conceded as inadvertent error. We conclude that petitioners are entitled to the cost of goods sold as claimed on the return. See Cohan v. Commissioner, 39 F.2d at 543-544; 6 Olive v. Commissioner, 139 T.C. at 32; Metra Chem Corp. v. 7 8 9 Commissioner, 88 T.C. at 661; Primo Pants Co. v. Commissioner, 78 T.C. at 723; Goldsmith v. Commissioner, 31 T.C. at 62. 10 Accuracy-Related Penalty 11 Section 6662(a) and (b)(1) and (2) imposes an 12 accuracy-related penalty on any portion of an underpayment 13 of Federal income tax that is attributable to the 14 15 taxpayer's "[n]egligence or disregard of rules or regulations" or "substantial understatement of income 16 tax." 17 18 19 20 21 22 An understatement of Federal income tax is substantial if the amount of the understatement for the taxable year exceeds the greater of 10% of the tax required to be shown on the return for the taxable year or $5,000. Sec. 6662(d)(1)(A). The term "negligence" in section 6662(b)(1) includes any failure to make a 23 reasonable attempt to comply with the Code and any failure 24 25 to keep adequate books and records or to substantiate items properly. Sec. 6662(c); sec. 1.6662-3(b)(1), Income (973)406-2250|operationseerrbers.net|www.esaiben.net Tax Regs. Negligence has also been defined as the failure to exercise due care or the failure to do what a reasonable person would do under the circumstances. See Allen v. Commissioner, 92 T.C. 1, 12 (1989), aff'd, 925 10 F.2d 348, 353 (9th Cir. 1991); see also Neely v. Commissioner, 85 T.C. 934, 947 (1985). The term "disregard" includes any careless, reckless, or intentional disregard. Sec. 6662(c). Under section 7491(c), the Commissioner bears 1 2 3 4 5 6 7 8 9 10 the burden of production with regard to penalties. See 11 Higbee v. Commissioner, 116 T.C. 438, 446 (2001). To meet 12 13 14 15 16 that burden the Commissioner must produce sufficient evidence to show that it is appropriate to impose the accuracy-related penalty. If the understatement of income tax for the year in issue is substantial, the Commissioner has satisfied the burden of producing evidence that the 17 penalty is justified. 18 Since we have concluded that petitioners are 19 entitled to deduct the full amount of cost of goods sold 20 21 22 23 24 claimed on their Schedule C, the only amount left is the $975 adjustment to the rental expenses which petitioners conceded. Given that this small amount relative to the amounts claimed we conclude that the underpayment of tax was not due to substantial understatement of income tax. 25 See sec. 6662(d)(1) (A). We also conclude that petitioners (973)406-2250]operationseestrbers.net|www.exrbers.net 11 were not negligent nor did they disregard rules or regulations or fail to make a reasonable attempt to comply with the provisions of the internal revenue laws. We conclude that petitioners made reasonable efforts to assess their proper tax liability. See sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs. Therefore, we also hold for petitioners with respect to the section 6662(a) accuracy-related penalty. To reflect the foregoing and petitioners' concession, a decision will be entered under Rule 155. And that concludes the Court's oral findings of fact and opinion in this case. (Whereupon, at 12:06 p.m., the above-entitled matter was concluded.) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Cdbers (973)406-2250|operationseerrbers.net|www.escrbers.net