Court Opinion

ID: 4333623
Source: CourtListenerOpinion
Date Created: 2018-11-14 01:17:10.421671+00
Date Added: 2024-06-11T14:48:00.897330
License: Public Domain

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 to redetermine the deficiency, R’s trial counsel
 informally contacted potential third-party witnesses
 without providing advance notice to Ps.
      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, is inapplicable with respect to R’s
 examination activities here, which all occurred before
 the Jan. 19, 1999, effective date of sec. 7602(c).
      2. Held, further, sec. 7602(c), I.R.C., is
 inapplicable with respect to R’s trial preparation
 activities.
      3. Held, further, sec. 7602(e), I.R.C., which
 restricts R’s use of financial status or economic
 reality examination techniques, is inapplicable with
 respect to R’s examination techniques which were
 employed before the July 22, 1998, effective date of
 sec. 7602(e), I.R.C.
      4. Held, further, Ps bear the burden of proof.
                               - 2 -

          5. Held, further, the allowable business expenses of
     Ps’ salvage business determined.
          6. Held, further, the cost of goods sold of Ps’
     salvage business determined.

     Samuel T. Seawright and Carol A. Seawright, pro sese.

     James R. Rich, for respondent.

     THORNTON, Judge:   Respondent determined a $6,125 deficiency

in petitioners’ joint 1995 Federal income tax.   The issues for

decision are:   (1) Whether respondent’s agents violated section

7602(c), which requires the Internal Revenue Service (IRS) to

give taxpayers advance notice of certain third-party contacts;

(2) whether respondent’s agents violated section 7602(e),

limiting respondent’s use of financial status or economic reality

examination techniques; (3) whether, pursuant to section 7491,

respondent bears the burden of proof; (4) whether petitioners are

entitled to deduct various business expenses of their salvage

business in amounts greater than respondent has allowed; and (5)

whether petitioners are entitled to reduce gross receipts from

their salvage business by certain amounts for cost of goods

sold.1

     1
       All section references are to the Internal Revenue Code as
in effect for the relevant taxable year, and all Rule references
are to the Tax Court Rules of Practice and Procedure.
                                 - 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.
                                - 4 -

     In 1992, Columbia “crushed out” all its inventory of junked

vehicles and other items, selling it as scrap metal.   In 1993 and

1994, Samuel continued to haul various items to petitioners’

scrap yard, including junked or abandoned vehicles.    Petitioners

did not pay for any of the items Samuel hauled away during these

years.   The only gross receipts generated from Columbia’s

business during 1993 and 1994 were attributable to some

automobile body work and other labor that Samuel performed.

     In 1995, Columbia recommenced rebuilding junked vehicles.

Between April and December 1995, petitioners spent a total of

$18,742 to purchase 14 junked vehicles (at a total cost of

$17,285) and various automotive parts (at a total cost of

$1,457).    Petitioners bought a number of these junked vehicles at

auctions conducted by Sadisco of Columbia (Sadisco), a company

which operated as a middleman between insurance companies in

possession of wrecked automobiles and dealers who buy them.

     During 1995, Columbia rebuilt or was in the process of

rebuilding at least six damaged vehicles, five of which were sold

to third parties in 1996 for an aggregate sales price of

$23,400.2   As required by State law, along with the application

of certificate for title/registration for each of these six

vehicles, there was filed with the South Carolina Department of

     2
       None of the rebuilt vehicles were sold in 1995. During
1995, petitioners sold none of its inventory to scrap dealers.
                                - 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
to sell the six rebuilt vehicles, Columbia North East Used Parts
(Columbia) first transferred title to petitioners’ son, Monty
Seawright (Monty), for no consideration. Monty then made
application for certificates of title/registration with the South
Carolina Department of Revenue and Taxation, Division of Motor
Vehicles (DMV).
     4
       The two remaining affidavits were filed in March and April
1996. On these affidavits, Samuel certified fair market
values of the other two rebuilt vehicles totaling $9,925.
                               - 6 -

goods sold of $18,742, and business expenses totaling $10,996,

resulting in a net loss of $8,886.     In computing cost of goods

sold, petitioners reported $1,500 opening inventory, $18,742

purchases, and $1,500 ending inventory.

Respondent’s Examination and Determinations

     On July 16, 1998, Carol had her first meeting with

respondent’s examining agent, Susan Leary (Leary), regarding

petitioners’ 1995 Federal income tax return.     At this initial

meeting, Leary asked Carol a number of routine background

questions, including but not limited to questions about

petitioners’ ages and education levels, and about their savings

and investments.   Leary also requested sales records relating to

Columbia.   At the initial meeting, Carol gave Leary no indication

where the sales records might be.

     Carol and Leary met on two subsequent occasions in August

1998.   At the subsequent meetings, Carol informed Leary that the

Columbia sales records had been lost.

     By notice of deficiency dated January 6, 2000, respondent

determined a $6,125 deficiency in petitioners’ 1995 Federal

income tax.   As part of this determination, respondent reduced

petitioners’ claimed Schedule C expenses by $7,212, as follows:
                                 - 7 -

                    Amount claimed
 Expense item         on return          Amount allowed   Adjustment

 Car & truck             –-                  $467           $(467)
 Depreciation            –-                   856            (856)
 Employee benefit
  program              $1,106                  –-            1,106
 Insurance                844                  –-              844
 Office expenses          514                  154             361
 Other rent             2,781                  -–            2,781
 Supplies               2,450                  –-            2,450
 Taxes &
  licenses              1,776                1,024             751
 Mortgage                 879                  879             –
 Utilities                646                  404             242
   Totals             $10,996               $3,784          $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.
                              - 8 -

                             OPINION

Third-Party Contacts

     Petitioners contend that respondent’s agents violated

section 7602(c) by contacting third parties without giving

petitioners proper advance notice.    Respondent contends that

section 7602(c) has no application to this case.

     Section 7602(c), which was added by section 3417 of the

Internal Revenue Service Restructuring and Reform Act of 1998

(RRA 1998), Pub. L. 105-206, 112 Stat. 757, provides as follows:

     (c) Notice of Contact of Third Parties.--

          (1) General notice.--An officer or employee of the
     Internal Revenue Service may not contact any person other
     than the taxpayer with respect to the determination or
     collection of the tax liability of such taxpayer without
     providing reasonable notice in advance to the taxpayer that
     contacts with persons other than the taxpayer may be made.

          (2) Notice of specific contacts.--The Secretary
     shall periodically provide to a taxpayer a record of
     persons contacted during such period by the Secretary
     with respect to the determination or collection of the
     tax liability of such taxpayer. Such record shall also
     be provided upon request of the taxpayer.

          (3) Exceptions.--This subsection shall not apply–-

               (A) to any contact which the taxpayer
          has authorized;

               (B) if the Secretary determines for good
          cause shown that such notice would jeopardize
          collection of any tax or such notice may
          involve reprisal against any person; or

               (C) with respect to any pending criminal
          investigation.
                                - 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
                               - 10 -

parties, including representatives of Sadisco, the Department of

Motor Vehicles (DMV), and certain purchasers of petitioners’

rebuilt vehicles.

     On reply brief, respondent concedes that in the course of

preparing for trial, respondent’s trial counsel contacted

potential witnesses without advance notice to petitioners.

Respondent contends that these contacts did not violate section

7602(c).   We agree with respondent.

     Section 7602(c) restricts the IRS’s third-party contacts

“with respect to the determination or collection of the tax

liability”.    The statute does not expressly indicate whether the

IRS’s trial preparations in the course of a court proceeding

should be considered to be “with respect to the determination or

collection of the tax liability”.

     The proposed regulations state that “Section 7602(c) does

not apply to contacts made in the course of a pending court

proceeding.”   Section 301.7602-2(f)(7), Proposed Proced. & Admin.

Regs., 66 Fed. Reg. 84 (Jan. 2, 2001).    Proposed regulations are

given no greater weight than a position advanced by respondent on

brief.   See F.W. Woolworth Co. v. Commissioner, 54 T.C. 1233,

1265-1266 (1970).    Nevertheless, they can be useful guidelines

where, as here, they closely follow the legislative history of

the statutory provision in question.    See Van Wyk v.

Commissioner, 113 T.C. 440, 444 (1999).
                                - 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 7602(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.5

     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
Revenue Service (IRS), may, in certain circumstances, determine
an additional deficiency after the taxpayer files a timely
petition with the Tax Court, and that in the course of making
such further determination, the IRS is not barred from exercising
its examination authority under sec. 7602(a). See United States
v. Gimbel, 782 F.2d 89, 93 (7th Cir. 1986) (pending Tax Court
proceedings did not bar IRS from invoking summons authority,
rather than using Tax Court discovery procedures, in seeking the
taxpayers’ financial records, where the taxpayers’ liability was
still subject to redetermination pursuant to sec. 6212(c));
Bolich v. Rubel, 67 F.2d 894, 895 (2d Cir. 1933 )(“Since the
Commissioner may apply to the Board [of Tax Appeals] to increase
the assessment [in the notice of deficiency], he may need to
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 the extent to which the restrictions of sec. 7602(c) might
apply with respect to examinations conducted by the IRS to
determine an additional deficiency pursuant to sec. 6212(c)
during the pendency of a Tax Court proceeding.
                              - 12 -

and the IRS’s examination and enforcement activities, see chapter

78 (captioned “Discovery of Liability and Enforcement of Title”).

Section 7602 (captioned “Examination of books and witnesses”)

appears in subchapter A (captioned “Examination and Inspection”)

of chapter 78.   Section 7602(a) contains a very broad grant of

authority to the IRS to examine books and records, issue summons,

and take testimony under oath for the purpose, inter alia, of

determining or collecting the Federal tax liability of any

person.   Section 7602(c) is drafted as a restriction on the

section 7602(a) examination authority.     The authority of the

IRS’s trial counsel to informally interview prospective third-

party witnesses to gather evidence in preparation for trial does

not emanate from section 7602(a).6     Consequently, section 7602(c)

     6
       The authority of the IRS’s trial counsel to conduct trial
preparation inheres in section 7452, which provides that the
Secretary shall be represented before the Tax Court by the Chief
Counsel of the IRS or his delegate. The exercise of this
authority is subject to the Tax Court’s Rules of Practice and
Procedure. See sec. 7453 (with exceptions not relevant here,
proceedings before the Tax Court shall be conducted in accordance
with such rules of practice and procedure as this Court may
prescribe).

     The Tax Court has not prescribed rules specifically relating
to informal pretrial interviews of potential witnesses. Cf. Fu
Inv. Co. v. Commissioner, 104 T.C. 408, 410 (1995) (“Arguably,
respondent’s efforts to arrange informal witness interviews do
not fall within our discovery procedures, and, thus, are not
subject to restriction under Rule 103”), citing Amarin Plastics,
Inc. v. Md. Cup Corp., 116 F.R.D. 36, 38 (D. Mass. 1987)
(interpreting Fed. R. Civ. P. 26(c)). Pursuant to this Court’s
standing pretrial order, however, respondent was required to
identify witnesses in his trial memorandum, which was required to
                                                   (continued...)
                              - 13 -

does not restrict that authority.

     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 least 15 days
before the trial session. Respondent complied with these
requirements of the standing pretrial order.
     7
       As a general matter, if the taxpayer has filed a petition
with this Court for a redetermination of the deficiency, the IRS
may not commence collection activities until this Court’s
decision has become final. Sec. 6213(a).
                               - 14 -

     Conclusion

     Petitioners have not shown that respondent’s agents violated

section 7602(c).

Statutory Limitation on Financial Status Audits

     Citing various background questions that Leary asked Carol

at their initial meeting on July 16, 1998, petitioners contend

that on or about that date respondent used a financial status or

economic reality examination technique in violation of section

7602(e).8

     Section 7602(e) became effective on the date of enactment of

RRA 1998; i.e., July 22, 1998.    H. Conf. Rept. 105-599, at 270

(1998), 1998-3 C.B. 755, 1024.    Petitioners do not contend that

any actions taken by respondent’s agents on or after July 22,

1998, violated section 7602(e).    Accordingly, section 7602(e) has

no application to this case.

Burden of Proof

     Petitioners contend that respondent bears the burden of

proof pursuant to section 7491.    Respondent contends that section

7491 is inapplicable.   We agree with respondent.

     8
       Sec. 7602(e), as added by Internal Revenue Service
Restructuring & Reform Act of 1998, Pub. L. 105-206, sec. 3412,
112 Stat. 751, provides:

          (e) Limitation on Examination of Unreported
     Income.--The Secretary shall not use financial status
     or economic reality examination techniques to determine
     the existence of unreported income of any taxpayer
     unless the Secretary has a reasonable indication that
     there is a likelihood of such unreported income.
                               - 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.
                                - 16 -

     Depreciation

     On their 1995 return, petitioners claimed no depreciation

deduction.    In the notice of deficiency, respondent allowed

petitioners a depreciation deduction of $856.    Petitioners have

not established that they are entitled to a depreciation

deduction greater than respondent has allowed.

     Employee Benefit Programs

     On brief, petitioners concede that they are not entitled to

any deduction for “Employee benefit programs” as claimed on their

1995 Schedule C.

     Insurance

     On their 1995 return, petitioners claimed an $844 deduction

for business insurance expense, all of which respondent

disallowed.    On the basis of our detailed review of the record,

we find that petitioners are entitled to a deduction of $262 for

insurance expense.

     Office Expenses

     On their 1995 return, petitioners claimed a $514 deduction

for office expenses.    In the notice of deficiency, respondent

allowed $154.     On the basis of our detailed review of the record,

we find that petitioners are entitled to a deduction of $319 for

office expenses.

     Other Rent

     On their 1995 return, petitioners claimed a $2,781 deduction

for “Other rent”, all of which respondent disallowed.
                                - 17 -

Petitioners have not established that they are entitled to any

deduction for “Other rent”.

     Supplies

     On their 1995 return, petitioners claimed a $2,450 deduction

for supplies, all of which respondent disallowed in the notice of

deficiency.     On brief, respondent concedes that petitioners

incurred $2,450 in expenses for materials used to rebuild

vehicles but contends that this amount should be added to

purchases in computing petitioners’ cost of goods sold, rather

than deducted as a current expense.      We agree with respondent.

     The evidence in the record indicates that the claimed

supplies expenses relate to petitioners’ rebuilding junked

automobiles for sale and that these expenses represented either

raw materials or supplies entering into the rebuilt automobiles

or direct labor relating thereto.     These amounts are includable

in the cost of petitioners’ rebuilt automobiles, see sec. 1.471-

3(c), Income Tax Regs., and thus are not deductible as trade or

business expenses pursuant to section 162(a) but rather enter

into the calculation of petitioners’ cost of goods sold in

determining their gross income, see Beatty v. Commissioner, 106

T.C. 268, 273 (1996).

     Small Tools

     Petitioners contend that they are entitled to a $281

deduction for small tools.     While small tools with a useful life
                               - 18 -

of less than 1 year are currently deductible, Clemons v.

Commissioner, T.C. Memo. 1979-273, the cost of tools with a

useful life that exceeds 1 year are recovered by depreciation,

secs. 167(a) and 168(b).

     Petitioners offered no evidence about the type, expected

useful life, or cost of each tool acquired.   Consequently, we

have no basis for determining which costs might be currently

deductible or for estimating appropriate depreciation deductions

for tools with useful lives greater than 1 year.

     Taxes and Licenses

     On their 1995 return, petitioners claimed a $1,776 deduction

for taxes and licenses.    In the notice of deficiency, respondent

allowed $1,024.   On the basis of our detailed review of the

record, we find that petitioners are entitled to a deduction of

$1,105 for taxes and licenses.

     Utilities

     On their 1995 return, petitioners claimed a $646 deduction

for utilities.    In the notice of deficiency, respondent allowed

$404.   Petitioners have not established that they are entitled to

a deduction for utilities expenses greater than respondent has

allowed.

     Cat Food

     On brief, respondent concedes that petitioners are entitled

to a $300 business expense deduction for cat food that
                                - 19 -

petitioners purchased and set out in their scrap yard for the

purpose of attracting wild cats to deter snakes and rats.

Cost of Goods Sold

     Petitioners contend that in 1995 Columbia had cost of goods

sold of $18,742, computed as follows:

               Opening Inventory            $1,500
               Add: Purchases               18,742
               Less: Closing Inventory       1,500
               Cost of Goods Sold          $18,742

     On brief, respondent concedes that petitioners have

substantiated purchases in the amount of $18,742 but contends

that petitioners have not established the value of their opening

or ending inventory, and thus are not entitled to reduce

Columbia’s gross receipts for cost of goods sold.    We agree with

respondent.

     In a manufacturing, merchandising, or mining business, gross

income means total sales less the cost of goods sold.     Sec. 1.61-

3(a), Income Tax. Regs.    Cost of goods sold is computed by

subtracting the value of ending inventory (goods still on hand at

the end of the year) from the sum of the opening inventory and

purchases during the year.     Primo Pants Co. v. Commissioner, 78

T.C. 705, 723 (1982).

     On their 1995 Federal income tax return, petitioners claimed

to have used the lower of cost or market as the basis for valuing

their inventory.     Under this approach, “the market value of each
                              - 20 -

article on hand at the inventory date shall be compared with the

cost of the article, and the lower of such values shall be taken

as the inventory value of the article.”   Sec. 1.471-4(c), Income

Tax Regs.9

     In 1992, Columbia disposed of all its then-existing

inventory.   Although they subsequently acquired additional items

of inventory, petitioners incurred no direct cost (and have

established no indirect costs) for the items acquired, prior to

their purchase of some junked vehicles in April 1995.

Consequently, Columbia’s opening inventory for 1995 had a cost of

zero, which is consistent with petitioners’ reporting of a zero

ending inventory for 1994.   See Steel or Bronze Piston Ring Corp.

v. Commissioner, 13 T.C. 636 (1949) (“consistency requires that

the opening inventory of each year correspond to the closing

inventory of the preceding year”).

     9
       The Supreme Court has summarized the lower of cost or
market approach as follows:

     The taxpayer must value inventory for tax purposes at
     cost unless the ‘market’ is lower. ‘Market’ is defined
     as ‘replacement cost,’ and the taxpayer is permitted to
     depart from replacement cost only in specified
     situations. When it makes any such departure, the
     taxpayer must substantiate its lower inventory
     valuation by providing evidence of actual offerings,
     actual sales, or actual contract cancellations. In the
     absence of objective evidence of this kind, a
     taxpayer’s assertions as to the ‘market value’ of its
     inventory are not cognizable in computing its income
     tax. [Thor Power Tool Co. v. Commissioner, 439 U.S.
     522, 535 (1979).]
                               - 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 $32,100.10

Petitioners’ contention is further undermined by evidence showing

that these four rebuilt automobiles, along with another vehicle

     10
       Although Columbia transferred title to the rebuilt
vehicles to Monty for no consideration before the vehicles were
sold to third parties, Samuel testified that the transfers to
Monty were not gifts, stating: “The fact is that these vehicles
were put in his [Monty’s] name in order to sell it [sic]. All of
them were reported as income through our business.”
Consequently, we ignore petitioners’ transfers of the rebuilt
automobiles to Monty.
                               - 22 -

contained in Columbia’s 1995 ending inventory, were sold to third

parties in 1996 for $23,400.

     In sum, petitioners have failed to show that the market

value of Columbia’s 1995 ending inventory was less than its

$21,192 cost.

     We conclude and hold that Columbia’s 1995 cost of goods sold

was zero, computed as $0 (opening inventory) plus $21,192

(purchases) minus $21,192 (ending inventory).   Accordingly,

respondent’s determination on this issue is sustained.

     All other contentions raised by the parties are irrelevant,

without merit, or moot.

     To reflect the foregoing and concessions of the parties,

                                         Decision will be entered

                                    Under Rule 155.