Court Opinion

ID: 9928665
Source: CourtListenerOpinion
Date Created: 2024-01-31 20:03:20.587755+00
Date Added: 2024-06-11T09:52:52.809808
License: Public Domain

United States Tax Court

                                 T.C. Memo. 2024-11

                             ESSEL EYEWEAR, INC.,
                                   Petitioner

                                            v.

               COMMISSIONER OF INTERNAL REVENUE,
                           Respondent

                                       __________

Docket No. 10823-22.                                         Filed January 31, 2024.

                                       __________

Joseph Y. Balisok, for petitioner.

Massimiliano Valerio and James P.A. Caligure, for respondent.

                           MEMORANDUM OPINION

        LAUBER, Judge: With respect to petitioner’s Federal income tax
for 2018 and 2019, the Internal Revenue Service (IRS or respondent)
determined deficiencies of $46,846 and $23,794, respectively, and pen-
alties of $9,369 and $4,759. The deficiencies stem from unreported gross
receipts and the disallowance of claimed deductions. Respondent has
filed a Motion for Summary Judgment under Rule 121, 1 contending that
there are no genuine disputes of material fact and that he is entitled to
judgment as a matter of law. We agree and accordingly will grant the
Motion.

        1 Unless otherwise indicated, statutory references are to the Internal Revenue

Code, Title 26 U.S.C. (Code), in effect at all relevant times, regulation references are
to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times,
and Rule references are to the Tax Court Rules of Practice and Procedure. We round
all monetary amounts to the nearest dollar.

                                   Served 01/31/24
                                    2

[*2]                           Background

       The following facts are based on the parties’ pleadings and re-
spondent’s Motion papers, including the Declarations and Exhibits at-
tached thereto. See Rule 121(c). We also rely on facts deemed admitted
by virtue of petitioner’s failure to respond to requests for admissions.
See Rule 90(f). Petitioner had its principal place of business in Brooklyn,
New York, when its Petition was timely filed.

      During 2018 and 2019 petitioner engaged in the business of sell-
ing eyewear at wholesale. It filed timely returns for both years on Form
1120, U.S. Corporation Income Tax Return. The IRS selected these re-
turns for examination and assigned the audit to Revenue Agent (RA)
Karen Chen.

       To verify the gross receipts reported on these returns, RA Chen
summonsed the bank records of petitioner and its sole shareholder. For
2018 she determined that an $11,000 business receipt belonging to peti-
tioner had been deposited into the shareholder’s account and was ex-
cluded improperly from petitioner’s gross receipts. For 2019 she deter-
mined that petitioner’s bank account had unexplained deposits of
$25,894 that should have been included in its gross receipts. She pro-
vided her bank deposits analysis to petitioner and its representative.
Neither presented any evidence that the $36,894 (or any portion thereof)
derived from nontaxable sources or was otherwise excludable from peti-
tioner’s gross income.

       To verify petitioner’s reported cost of goods sold (COGS) and busi-
ness expense deductions, RA Chen requested substantiation from peti-
tioner. Its representative supplied documents in several phases during
2021, and RA Chen revised her findings accordingly. She determined
that petitioner had substantiated only a portion of its reported COGS,
advertising expenses, and “other” deductions for 2018 and 2019 and that
it had substantiated none of a $2,000 bad debt deduction claimed for
2019. On the other hand, she concluded that petitioner should be al-
lowed an additional deduction of $6,500 for each year for rental ex-
penses.

       On October 1, 2021, RA Chen prepared and forwarded to her man-
ager for approval a draft 30-day letter setting forth her proposed adjust-
ments. She included in this package a civil penalty approval form rec-
ommending that a 20% accuracy-related penalty be asserted for each
year. Acting Group Manager (AGM) Nadezhda Khasin returned the
                                          3

 [*3] package that same day, approving the assertion of 20% penalties
 for substantial understatements of income tax (or alternatively for neg-
 ligence). See § 6662(a) and (b)(1) and (2). The form bears AGM Khasin’s
 digital signature dated October 1, 2021.

        RA Chen forwarded her draft report to petitioner and revised it
 after receiving additional information. On November 30, 2021, she fi-
 nalized her examination report. After adjusting petitioner’s gross re-
 ceipts, COGS, and allowable deductions in accordance with her findings,
 she determined that petitioner’s 2018 taxable income should be in-
 creased from $30,268 to $253,342, and that its 2019 taxable income
 should be increased from $20,293 to $133,600. These adjustments gen-
 erated income tax deficiencies of $46,846 and $23,794:

    2018 Return Item       As Reported        Adjustment          As Redetermined

Gross Receipts               $701,724                  $11,000           $712,724

Returns/Allowances              (6,983)          -0-                       (6,983)

COGS                          (419,427)                150,421           (269,006)

Gross Profit                 $275,314              $161,421              $436,735

Salaries                       (15,000)          -0-                      (15,000)

Repairs                        (13,986)          -0-                      (13,986)

Taxes                           (1,219)          -0-                       (1,219)

Charitable Contributions        (3,363)          -0-                       (3,363)

Rents                          (12,000)                 (6,500)           (18,500)

Advertising                    (44,042)                 24,959            (19,083)

Other Deductions              (155,436)                 43,194           (112,242)

Total Deductions            ($245,046)                 $61,653          ($183,393)

Taxable Income                $30,268              $223,074              $253,342

Tax Liability                   $6,356                 $46,846            $53,202
                                          4

 [*4]
2019 Return Item           As Reported        Adjustment          As Redetermined

Gross Receipts                $770,798                 $25,894           $796,692

Returns/Allowances              (5,723)          -0-                       (5,723)

COGS                          (391,128)                 39,802           (351,326)

Gross Profit                 $373,947                  $65,696           $439,643

Salaries                       (19,500)          -0-                      (19,500)

Repairs                        (86,024)          -0-                      (86,024)

Bad debts                       (2,000)                  2,000                   0

Taxes                           (1,492)          -0-                       (1,492)

Charitable Contributions        (1,981)          -0-                       (1,981)

Rents                          (12,000)                 (6,500)           (18,500)

Advertising                    (44,047)                 25,047            (19,000)

Other Deductions              (186,610)                 27,063           (159,547)

Total Deductions            ($353,654)                 $47,610          ($306,044)

Taxable Income                $20,293             $113,307               $133,600

Tax Liability                  $4,262              $23,794                $28,056

        RA Chen sent her final report to petitioner and its representative
 but received no further response. On January 5, 2022, her manager
 closed the examination. On April 5, 2022, the IRS issued petitioner a
 notice of deficiency determining the tax deficiencies and penalties set
 forth supra page 1.

        On May 9, 2022, petitioner timely petitioned this Court, assigning
 error to every determination in the notice of deficiency. Shortly after
 respondent filed his Answer, the case was referred to the IRS Independ-
 ent Office of Appeals (Appeals) to consider whether the case could be
                                     5

[*5] resolved without trial. In August 2022 the case was assigned to an
Appeals officer (AO), who requested substantiation supporting peti-
tioner’s return position and the assignments of error in the Petition. Pe-
titioner had supplied no relevant information to the AO as of January
2023, when this case was placed on a May trial calendar.

       On February 13, 2023, respondent served on petitioner a First
Request for Admissions. In 11 numbered paragraphs, respondent asked
petitioner to admit that it had “no documents” showing that the IRS
erred in adjusting its gross receipts, COGS, advertising expenses, bad
debt deduction, and “other” deductions as set forth in the notice of defi-
ciency. Respondent advised petitioner that “pursuant to Tax Court
Rules 90(c) and 90(f), each matter in the foregoing requests will be
deemed admitted, and conclusively established for purposes of this case,
unless you serve a written answer or an objection to these requests
within 30 days after the date these requests for admissions were served
on you.” Petitioner filed no response to the First Request for Admissions
by the March 15 deadline or subsequently. The matters covered by that
request are thus deemed admitted. See Rule 90(c).

        On March 8, 2023, the case was continued from the May trial cal-
endar upon a representation from petitioner’s counsel that “[p]etitioner
is actively working with IRS Office of Appeals . . . to settle the outstand-
ing issues raised in the Petition.” On June 8, 2023, the AO informed
respondent’s counsel that petitioner had supplied no substantiation or
documentation of any kind during the Appeals process. Petitioner was
sent a “last chance” letter, but it supplied nothing in response to that
letter.

       On July 6, 2023, the AO returned the case to respondent’s counsel
for trial preparation. On July 20, 2023, respondent served on peti-
tioner’s counsel a Second Request for Admissions. Respondent asked
petitioner to admit that a civil penalty approval form, attached as Ex-
hibit A to the Request, was a “true and genuine copy” of the civil penalty
approval form signed by AGM Khasin on October 1, 2021. Respondent
also requested that petitioner admit that AGM Khasin’s approval was
timely secured, that petitioner for 2018 and 2019 “is liable for the sub-
stantial understatement penalty . . . in the amounts determined in the
statutory notice of deficiency,” and that “[t]he adjustments and compu-
tations in the statutory notice of deficiency . . . are correct in all re-
spects.”
                                    6

[*6] The Second Request for Admissions (like the First) advised peti-
tioner that “pursuant to Tax Court Rules 90(c) and 90(f), each matter in
the foregoing requests will be deemed admitted, and conclusively estab-
lished for purposes of this case, unless you serve a written answer or an
objection to these requests within 30 days after the date these requests
for admissions were served on you.” Petitioner did not respond to the
Second Request for Admissions by the August 19 deadline or subse-
quently. The matters covered therein are thus deemed admitted. See
Rule 90(c).

       On September 1, 2023, the Court placed this case on a January
22, 2024, New York, New York, trial calendar. On September 28, 2023,
respondent filed a Motion for Summary Judgment, urging that the defi-
ciencies and penalties set forth in the notice of deficiency should be sus-
tained in full. We directed petitioner to respond to the Motion by Octo-
ber 30, 2023, warning that “under Tax Court Rule121(d), judgment may
be entered against a party who fails to respond to a Motion for Summary
Judgment.” Petitioner did not respond to the Motion by that date or
subsequently.

                               Discussion

I.    Summary Judgment

       The purpose of summary judgment is to expedite litigation and
avoid costly, time-consuming, and unnecessary trials. Fla. Peach Corp.
v. Commissioner, 90 T.C. 678, 681 (1988). The Court may grant sum-
mary judgment when there is no genuine dispute as to any material fact
and a decision may be rendered as a matter of law. Rule 121(a)(2);
Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff’d, 17
F.3d 965 (7th Cir. 1994). In deciding whether to grant summary judg-
ment, we construe factual materials and inferences drawn from them in
the light most favorable to the nonmoving party. Sundstrand Corp., 98
T.C. at 520.

       Facts deemed admitted under Rule 90(c) are considered conclu-
sively established and may be relied upon in deciding whether to grant
a motion for summary judgment. See Marshall v. Commissioner, 85 T.C.
267, 272–73 (1985); Morrison v. Commissioner, 81 T.C. 644, 651–52
(1983); Doncaster v. Commissioner, 77 T.C. 334, 336 (1981). Where the
moving party makes and properly supports a motion for summary judg-
ment, “the nonmovant may not rest on the allegations or denials in that
party’s pleading” but must set forth specific facts, by affidavit or
                                   7

[*7] otherwise, showing that there is a genuine dispute for trial. Rule
121(d); see Sundstrand Corp., 98 T.C. at 520.

       Because petitioner did not respond to the Motion for Summary
Judgment, we could enter a decision against it for that reason alone. See
Rule 121(d). We will nevertheless consider the Motion on its merits.
Given the facts deemed admitted, we conclude that no material facts are
in genuine dispute and that this case is appropriate for summary adju-
dication.

II.    Burden of Proof

       The Commissioner’s determinations in a notice of deficiency are
generally presumed correct, and the taxpayer bears the burden of prov-
ing them erroneous. Rule 142(a); see Welch v. Helvering, 290 U.S. 111,
115 (1933). In certain circumstances section 7491 may shift to the Com-
missioner the burden of proof on factual issues. But that section applies
only if the taxpayer (among other things) “introduces credible evidence”
and “has maintained all records required under this title.” See
§ 7491(a)(1), (2)(B). Petitioner does not contend, and it could not plau-
sibly contend, that it met these requirements.

III.   Gross Income

       “[G]ross income means all income from whatever source derived,”
including income derived from business. § 61(a); Commissioner v. Glen-
shaw Glass Co., 348 U.S. 426, 429–31 (1955). In cases of unreported
income, the Commissioner must establish an evidentiary foundation
connecting the taxpayer with the income-producing activity, see Llorente
v. Commissioner, 649 F.2d 152, 156 (2d Cir. 1981), aff’g in part, rev’g
and remanding in part 74 T.C. 260 (1980), or demonstrate that the tax-
payer actually received income, Edwards v. Commissioner, 680 F.2d
1268, 1270–71 (9th Cir. 1982). “Once the Commissioner makes the re-
quired threshold showing, the burden shifts to the taxpayer to prove by
a preponderance of the evidence that the Commissioner’s determina-
tions are arbitrary or erroneous.” Walquist v. Commissioner, 152 T.C.
61, 67–68 (2019) (citing Helvering v. Taylor, 293 U.S. 507, 515 (1935));
see Texasgulf, Inc., & Subs. v. Commissioner, 172 F.3d 209, 214 (2d Cir.
1999), aff’g 107 T.C. 51 (1996).

       The Commissioner reconstructed petitioner’s income using the
bank deposits method. Taxpayers must maintain books and records suf-
ficient to establish their income and expenses. §§ 6001, 446(b); Petzoldt
v. Commissioner, 92 T.C. 661, 693 (1989); Treas. Reg. § 1.6001-1(a).
                                     8

[*8] When a taxpayer fails to do so, the Commissioner may reconstruct
its income by examining its bank deposits. See Estate of Hague v. Com-
missioner, 132 F.2d 775 (2d Cir. 1943), aff’g 45 B.T.A. 104 (1941); DiLeo
v. Commissioner, 96 T.C. 858, 881 (1991), aff’d, 959 F.2d 16 (2d Cir.
1992). Bank deposits are prima facie evidence of income, and the Com-
missioner need not show a likely source of the revenue. Tokarski v.
Commissioner, 87 T.C. 74, 77 (1986). We presume that all money depos-
ited into a taxpayer’s account is taxable unless the taxpayer shows that
particular deposits are nontaxable or were previously reported as in-
come. DiLeo, 96 T.C. at 868; Brodsky v. Commissioner, T.C. Memo.
2001-240, 82 T.C.M. (CCH) 505, 530.

        RA Chen summonsed the bank records of petitioner and its sole
shareholder. Analyzing the data in those accounts, she prepared and
supplied to petitioner a bank deposits analysis—complete with her sup-
porting worksheets—showing that petitioner had additional gross re-
ceipts of $11,000 for 2018 and $25,894 for 2019. Petitioner provided no
evidence that these deposits reflected nontaxable items or that her anal-
ysis was incorrect in any respect. We accordingly find that respondent’s
implementation of the bank deposits method was reasonable and pro-
vided a sufficient evidentiary foundation connecting petitioner with the
unreported income. See Petzoldt, 92 T.C. at 687 (noting that the IRS’s
reconstruction of a taxpayer’s income “need only be reasonable in light
of all surrounding facts and circumstances”).

       In any event, petitioner failed to respond to both Requests for Ad-
missions. Petitioner is thus deemed to have admitted that the adjust-
ments in the notice of deficiency “are correct in all respects” and that “it
does not have any documents showing that respondent erred” in calcu-
lating its gross income. See Rule 90(c). These deemed admissions alone
suffice to establish that no genuine dispute exists as to the issue of un-
reported income. See Marshall, 85 T.C. at 272–73. We accordingly con-
clude that respondent’s determinations of unreported gross receipts for
2018 and 2019, as set forth in the notice of deficiency, are correct, and
those determinations are sustained. See Hardy v. Commissioner, 181
F.3d 1002, 1004–05 (9th Cir. 1999), aff’g T.C. Memo. 1997-97; Pow-
erstein v. Commissioner, T.C. Memo. 2011-271, 102 T.C.M. (CCH) 497,
506.

IV.   Cost of Goods Sold and Deductions

       Deductions are a matter of legislative grace, and taxpayers gen-
erally bear the burden of proving that claimed business expenses were
                                          9

[*9] actually incurred and were “ordinary and necessary.” § 162(a);
Rule 142(a); see INDOPCO Inc. v. Commissioner, 503 U.S. 79, 84 (1992);
New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). Taxpayers
also bear the burden of substantiating the amounts of their deductions
by keeping and producing records sufficient to enable the IRS to deter-
mine the correct tax liability. See § 6001; Treas. Reg. § 1.6001-1(a).

       “Costs of goods sold” is an offset subtracted from gross receipts in
determining gross income. Treas. Reg. § 1.61-3(a). Technically speak-
ing, COGS is not a “deduction.” See Metra Chem Corp. v. Commissioner,
88 T.C. 654, 661 (1987). However, any amount claimed as COGS also
must be substantiated, and taxpayers are required to maintain records
sufficient for this purpose. § 6001; Nunn v. Commissioner, T.C. Memo.
2002-250, 84 T.C.M. (CCH) 403, 408; Treas. Reg. § 1.6001-1(a).

        RA Chen concluded, on the basis of documents supplied during
the examination, that petitioner had failed to substantiate a portion of
its reported COGs, advertising expenses, and other deductions for 2018
and 2019 and had substantiated none of the bad debt deduction reported
for 2019. After receiving RA Chen’s final examination report, petitioner
provided no evidence to her, to the AO, or to respondent’s counsel to sub-
stantiate the amounts disallowed. Because petitioner failed to meet its
burden of substantiation, we can sustain respondent’s disallowance of
its claimed deductions and expenses on this ground alone. 2

       In any event, petitioner failed to respond to respondent’s Re-
quests for Admissions and is thus deemed to have admitted that the ad-
justments in the notice of deficiency are “correct in all respects” and that
no documents exist showing that respondent erred in disallowing the
amounts of these items. See Rule 90(c). Petitioner’s deemed admissions
suffice to establish that no genuine dispute exists regarding the disal-
lowed COGS and deductions for 2018 and 2019 and the disallowed bad
debt expense for 2019. See Marshall, 85 T.C. at 272–73. We accordingly
conclude that respondent’s determinations on these points, as set forth

        2 If a taxpayer establishes that deductible expenses were incurred but fails to

establish the precise amounts, we may estimate allowable amounts in appropriate cir-
cumstances. Cohan v. Commissioner, 39 F.2d 540, 543–44 (2d Cir. 1930). However,
there must be evidence in the record that provides a rational basis for such an esti-
mate. Vanicek v. Commissioner, 85 T.C. 731, 742–43 (1985). We are not obligated to
make an estimate under the Cohan rule where there is insufficient record evidence to
enable a rational estimate. See Lerch v. Commissioner, 877 F.2d 624, 627–29 (7th Cir.
1989) (refusing to apply the Cohan rule where the taxpayer failed to present evidence
to support the claimed deduction), aff’g T.C. Memo. 1987-295.
                                    10

[*10] in the notice of deficiency, are correct, and those determinations
are sustained. See Hardy v. Commissioner, 181 F.3d at 1004; Pow-
erstein, 102 T.C.M. (CCH) at 506.

V.    Accuracy-Related Penalties

       The Code imposes a 20% penalty upon the portion of any under-
payment attributable to any “substantial understatement of income
tax.” See § 6662(a), (b)(2). For a subchapter C corporation such as peti-
tioner, a substantial understatement of income tax is an understate-
ment that exceeds the lesser of 10% of the tax required to be shown on
the return (or, if greater, $10,000) or $10 million. § 6662(d)(1)(B). The
Commissioner has no burden of production with respect to the penalty
where the taxpayer is a corporation. NT, Inc. v. Commissioner, 126 T.C.
191, 195 (2006) (noting that section 7491(c), which places the burden of
production with respect to penalties on the Commissioner, does not ap-
ply to corporations, only “individual[s]”).

       Petitioner reported tax liabilities of $6,356 and $4,262, respec-
tively, on its returns for 2018 and 2019. The notice of deficiency—the
adjustments in which we have sustained—determined tax liabilities of
$53,202 and $28,056, respectively. This leaves understatements of
$46,846 for 2018 ($53,202 − $6,356) and $23,794 for 2019 ($28,056 −
$4,262). Each year’s understatement of income tax exceeded the 10%
threshold and was thus “substantial.”

         No penalty is imposed under section 6662 with respect to any por-
tion of an underpayment “if it is shown that there was a reasonable
cause for such portion and that the taxpayer acted in good faith with
respect to [it].” § 6664(c)(1). Petitioner has supplied no evidence to es-
tablish reasonable cause or good faith. Quite the contrary, by failing to
respond to the Second Request for Admissions, petitioner is deemed to
have admitted that it “is liable for the substantial understatement pen-
alty . . . in the amounts determined in the statutory notice of deficiency.”
We will accordingly sustain the penalties as determined by the Commis-
sioner.

      To reflect the foregoing,

      An appropriate order and decision will be entered for respondent.