Thorpe v. Commissioner

T.C. Memo. 1998-123

UNITED STATES TAX COURT

KAREN L. THORPE, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 20798-96, 20970-96.1 Filed March 30, 1998.

Karen L. Thorpe, pro se.

William J. Gregg, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

RUWE, Judge: In these consolidated cases, respondent

determined deficiencies in petitioner's Federal income taxes and

accuracy-related penalties as follows:

1
The case at docket No. 20798-96 concerns petitioner's
taxable year 1993, and the case at docket No. 20970-96 concerns
petitioner's taxable year 1994.
 - 2 -

Accuracy-related Penalty
Year Deficiency Sec. 6662

1993 $7,686 $149
1994 8,776 1,626

After concessions,2 the issues remaining for decision are:

(1) Whether petitioner is entitled to reduce gross receipts in

her wholesale activity by certain amounts for cost of goods sold;

(2) whether petitioner is entitled to deduct various expenses

incurred in her wholesale and consulting activities; (3) whether

2
Petitioner concedes that for the taxable year 1993, she
omitted from income interest income from Marbury Associates of
$43 and interest income of $44 from Riggs National Bank; wages in
the amount of $817 received from Leger Enterprises, Ltd.; and
nonemployee compensation income in the amount of $1,215 received
from Hanover Capital Partners, Ltd. Petitioner also concedes
that she is not entitled to a deduction for professional services
expenses in 1993 related to her wholesale activity; travel and
entertainment expenses in 1993 and 1994 to the extent that such
deductions are comprised of expenses other than telephone,
laundry, gas, and tolls; and a charitable contribution expense of
$1,000 in 1994 reported on Schedule C in relation to her
wholesale activity.

For the taxable year 1993, respondent concedes that
petitioner is entitled to deduct car and truck expenses in the
amount of $311; tolls in the amount of $5 related to petitioner's
wholesale activity; telephone expenses in the amount of $323
related to her consulting activity; and additional charitable
contributions in the total amount of $4,803, in addition to the
$922 allowed in the notice of deficiency. Respondent also
concedes that petitioner is entitled to claim an additional
credit in the amount of $109 for withholding tax on income
petitioner received from Leger Enterprises, Ltd. in 1993.

For the taxable year 1994, respondent concedes that
petitioner is entitled to deduct legal and professional fees
related to petitioner's consulting activity in the amount of $205
and charitable contributions in the total amount of $5,855.
 - 3 -

petitioner is entitled to itemized charitable contribution

deductions in the amounts of $6,472 in 1993 and $6,813 in 1994;

and (4) whether petitioner is liable for accuracy-related

penalties pursuant to section 6662.3

FINDINGS OF FACT

Some of the facts have been stipulated and are so found.

The stipulation of facts is incorporated herein by this

reference. At the time the petitions were filed, petitioner

resided in Norfolk, Virginia.

Prior to the years in issue, petitioner graduated from

college and received a bachelor's degree in business

administration and accounting. Petitioner worked over 19 years

as a national bank examiner and has more than 24 years of

professional experience in banking, accounting, and auditing.

During the years in issue, petitioner was engaged in two

different activities which she reported on Schedules C, Profit or

Loss From Business, of her 1993 and 1994 Federal income tax

returns. On Schedules C, attached to her 1993 and 1994 income

tax returns, petitioner listed her principal business or

profession as "wholesale merchant" and "wholesale sales"

3
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
 - 4 -

(wholesale activity), respectively. In operating her wholesale

activity, petitioner purchased merchandise including T-shirts,

sweatshirts, and apparel accessories that she sold through mail

order advertisements and in person as a street vendor. On

separate Schedules C for 1993 and 1994, petitioner listed her

second activity as "banking institutions" and "financial

consultant" (consulting activity), respectively. In operating

her consulting activity, petitioner did financial consulting work

for both private banking institutions and Government agencies.

On her Schedules C for 1993 and 1994, petitioner reported

the following items of income and expenses related to her

wholesale and consulting activities:

Wholesale Consulting

Description 1993 1994 1993 1994

Income:
Gross receipts or sales: $2,000 $0 $17,667 $22,738

Cost of goods sold:

Beginning inventory (2,450) (1,392) 0 0
Purchases (4,700) (1,613) 0 0
Ending inventory 1,392 150 0 0

(5,758) (2,855) 0 0

Gross income: (3,758) (2,855) 17,667 22,738

Expenses:

Advertising 575 326 0 0
Car & truck 4,634 1,363 1,372 5,481
Depreciation 1,785 0 0 1,288
Insurance 578 200 0 0
Other interest 942 0 0 0
 - 5 -

Supplies 633 390 0 0
Taxes & licenses 120 0 0 0
Travel 489 200 2,751 2,940
Meals & entertainment 100 210 704 1,400
Utilities 725 0 0 0
Business cards 47 0 0 0
Dues & publications 72 53 0 0
Setup fees 0 300 0 0
Telephone 0 545 915 947
Small tools 0 200 838 900
Vendor fees 0 734 0 0
P.O. Box 0 25 0 0
Donations 0 2,000 0 0
Conference/training 300 958 0 0
Miscellaneous 612 150 530 176
Professional services 1,100 400 1,100 650

Total expenses (12,712) (8,054) (8,210) (13,782)

Net profit (16,470) (10,909) 9,457 8,956

In the notice of deficiency for 1993, respondent disallowed

petitioner's cost of goods sold reduction to gross receipts

related to petitioner's wholesale activity to the extent that the

reduction exceeded gross receipts of $2,000. For the taxable

year 1994, respondent disallowed all petitioner's cost of goods

sold reduction to gross receipts related to petitioner's

wholesale activity. Respondent disallowed all the expenses

associated with petitioner's wholesale activity in 1993 and 1994.

With respect to petitioner's consulting activity, respondent

disallowed $6,029 of expenses deducted by petitioner in 1993 and

all the deductions reported by petitioner in 1994.

On Schedules A, Itemized Deductions, petitioner reported

gifts to charity of $6,150 in 1993 and $6,313 in 1994 for alleged

cash contributions to various organizations. Also on Schedules
 - 6 -

A, petitioner reported $322 in 1993 and $500 in 1994 for alleged

noncash contributions to various charities. In addition, in 1994

petitioner reported "donations" in the amount of $2,000 on

Schedule C in relation to her wholesale activity. In the notices

of deficiency, respondent disallowed $5,550 of petitioner's cash

contributions in 1993 and disallowed all petitioner's reported

contributions, both cash and noncash, in 1994.

Petitioner used the services of Mr. Stephen M. Baker, who

prepared petitioner's tax returns for the years in issue.

OPINION

Petitioner testified that she sold merchandise in her

wholesale activity at a "markup". Respondent argues that because

petitioner sold items at a markup, her sales could not have

resulted in a negative gross profit. Respondent determined that

petitioner is not entitled to cost of goods sold in any amount in

excess of the amount of gross receipts, which were reported on

petitioner's returns in 1993 and 1994. Petitioner has failed to

produce any evidence to refute the logic of respondent's

determination.

Cost of goods sold is an offset to gross receipts in

determining business gross income. Metra Chem Corp. v.

Commissioner, 88 T.C. 654, 661 (1987); sec. 1.61-3(a), Income Tax

Regs. Although cost of goods sold is not a deduction and,
 - 7 -

therefore, not subject to the limitations on deductions found in

section 162, any amount allowed as cost of goods sold must be

substantiated. Sec. 6001; Ranciato v. Commissioner, T.C. Memo.

1993-536; sec. 1.6001-1(a), Income Tax Regs.

In order to reflect taxable income correctly, inventories

at the beginning and end of each taxable year are necessary in

every case in which the sale of merchandise is an income-

producing factor. Cheesman v. Commissioner, T.C. Memo. 1994-509;

sec. 1.471-1, Income Tax Regs. At trial, petitioner offered

numerous canceled checks and invoices to substantiate inventory

purchased during each year. However, petitioner did not offer

any evidence to substantiate either the amount or value of her

beginning and ending inventory in 1993 and 1994. At the

beginning of 1993, petitioner reported an inventory balance of

$2,450. During 1993 and 1994, petitioner substantiated purchases

of inventory in the amount of $6,313.4 By the end of 1994,

petitioner's Schedule C for her wholesale activity indicated that

her inventory was only $150. However, in relation to her

wholesale activity, petitioner reported only $2,000 of gross

receipts in 1993 and zero gross receipts in 1994. Assuming

petitioner sold her inventory at cost during 1993 and 1994, she

would have in excess of $6,000 of inventory at the end of 1994,

4
Petitioner purchased inventory in 1993 and 1994 in the
amounts of $4,700 and $1,613, respectively.
 - 8 -

provided her inventory did not substantially lose its value.5

However, petitioner asserts that at the end of 1994 there was

only a balance of $150 in inventory.6 Petitioner made no attempt

to substantiate her beginning and ending inventory figures. We

do not find petitioner's calculations of cost of goods sold to be

reliable, because beginning and ending inventory figures were not

supported by evidence. Consequently, petitioner may not reduce

her gross receipts by any amount in excess of that determined by

respondent in the notices of deficiency.

In the notices of deficiency for the taxable years 1993 and

1994, respondent disallowed various expenses related to

petitioner's wholesale and consulting activities. Respondent

determined that petitioner did not meet her burden of proof that

these expenses were actually incurred.

5
This can be demonstrated by the following calculation:

Beginning inventory 1993 $2,450
Purchases 1993 and 1994 6,313
Amount sold (at cost) (2,000)

Ending inventory 1994 $6,763 (projected)

This also assumes, though we do not decide, that
petitioner's reported amount for beginning inventory was correct.
6
At trial, petitioner's accountant testified that items sold
by petitioner were all sold to various customers at a price from
$2 to $10 greater than her cost for the items. If petitioner did
sell the inventory at some level of markup, we note that the
ending inventory figure would be higher.
 - 9 -

Deductions are a matter of legislative grace, and the

taxpayer bears the burden of proving that he or she is entitled

to any deduction claimed. New Colonial Ice Co. v. Helvering, 292

U.S. 435, 440 (1934); Welch v. Helvering, 290 U.S. 111 (1933).

Taxpayers must substantiate the amount of any deductions claimed.

Hradesky v. Commissioner, 65 T.C. 87, 89 (1975), affd. per curiam

540 F.2d 821 (5th Cir. 1976). Taxpayers are required to keep

sufficient records to enable the Commissioner to determine their

correct tax liability. Sec. 6001. Entertainment expenses,

moreover, must satisfy more stringent substantiation

requirements. Sec. 274(d).

At trial, petitioner offered evidence substantiating

expenses for 1993 and 1994 in the amounts of $709.39 and $882.64,

respectively, for "small tools", which were deducted on Schedules

C for her consulting activities. No other substantiation was

introduced into evidence for other expenses associated with

petitioner's consulting activity. Therefore, petitioner is not

entitled to expenses in excess of the above-mentioned expenses

for small tools and those expenses allowed by respondent in the

notices of deficiency.

With respect to petitioner's wholesale activity, petitioner

offered evidence substantiating advertising expenses of $326,

which were deducted on her Schedule C in 1994. No other evidence

was introduced in regard to other expenses reported by petitioner
 - 10 -

on her 1993 and 1994 Schedules C for her wholesale activity.

Therefore, in 1994 petitioner is not entitled to expenses in

excess of the $326 for advertising expense and those expenses

allowed by respondent in the notice of deficiency.

Petitioner claimed itemized charitable deductions in the

amounts of $6,472 and $6,813 for the taxable years 1993 and 1994,

respectively. Respondent disallowed the expenses in the notices

of deficiency. As previously indicated, respondent has conceded

a large percentage of these deductions. Respondent contends that

any additional amounts of contributions were not properly

substantiated. Petitioner now asserts she is entitled to deduct

additional amounts not reported on her 1993 Federal income tax

return for contributions of property other than money.

Charitable contributions are deductible under section 170

only if verified under regulations prescribed by the Secretary.

Sec. 170(a)(1). Under the applicable regulations, contributions

of money made in taxable years beginning after December 31, 1982,

are required to be substantiated by one of the following: (1) A

canceled check; (2) a receipt from the donee charitable

organization showing the name of the donee, the date, and amount

of the contribution; or (3) in the absence of a canceled check or

receipt, other reliable written records showing the name of the

donee, the date, and amount of the contribution. Burrell v.
 - 11 -

Commissioner, T.C. Memo. 1994-574; sec. 1.170A-13(a)(1), Income

Tax Regs.

If a charitable contribution is made in property other than

money, the amount of the contribution is, generally, the fair

market value of the property at the time of the contribution.

Sec. 1.170A-1(c)(1), Income Tax Regs. Further, any taxpayer who

makes a charitable contribution of property other than money in a

taxable year beginning after December 31, 1982, shall maintain

for each contribution written records from the donee showing the

name and address of the donee, the date and location of the

contribution, and a description of the property in detail

reasonably sufficient under the circumstances. Sec. 1.170A-

13(b), Income Tax Regs. The fair market value of the property is

one of the circumstances to be taken into account in determining

the amount of detail to be included on the receipt. Id.

At trial, with respect to contributions of cash in 1993 and

1994, petitioner offered as evidence schedules which summarize

entries made in her check registers during each of the years 1993

and 1994. The schedules list check numbers, dates on which the

checks were drawn, the names of the various payee organizations,

and the amounts of each check. In conjunction with the summary

schedules, petitioner also submitted as evidence her check

registers from 1993 and 1994, which contain entries that

correspond to the various amounts appearing on the summary
 - 12 -

schedules. Finally, petitioner submitted a number of checkbooks

that contain carbon copies of some of the checks written during

the years 1993 and 1994. We find that petitioner's summary

schedules and check registers combined with carbon copies of a

number of the checks, qualify as reliable written records showing

the name of the donee, the date, and amount of the contribution.

Sec. 1.170A-13(a)(1), Income Tax Regs. Therefore, petitioner is

entitled to deductions for cash contributions of $6,150, the

amount shown on her 1993 Schedule A. Petitioner is also entitled

to a deduction of the full amount of cash contributions reported

on her Schedule A in 1994 in the amount of $6,313.

With respect to contributions of property other than money,

petitioner offered a receipt from the AMVETS National Service

Foundation (AMVETS), dated April 1993, which lists various items

of property totaling $2,300. Petitioner offered three other

receipts each listing various items of property given to the

Salvation Army all within the year 1993. The three receipts from

the Salvation Army purport to assign a total value to the items

listed in each receipt of $1,480, $1,003, and $1,657. Petitioner

did not deduct any of the amounts, which are listed on the AMVETS

or Salvation Army receipts, on her 1993 Federal income tax

return. Petitioner did not explain why she did not initially

deduct these amounts. Moreover, petitioner testified that she

based the values assigned to the items on the AMVETS and
 - 13 -

Salvation Army receipts on the original cost of the items.

Petitioner did not provide any evidence of the fair market value

of the property at the time of the alleged contributions.

Because petitioner assigned original cost values to all the items

rather than fair market value at the time the items were donated

as required by section 1.170A-1(c), Income Tax Regs., petitioner

has not established entitlement to a deduction for any of the

items listed on the AMVETS or Salvation Army receipts.

Respondent determined that petitioner is liable for

accuracy-related penalties under section 6662. Section 6662(a)

imposes a penalty in an amount equal to 20 percent of the portion

of the underpayment of tax attributable to one or more of the

items set forth in section 6662(b). Respondent asserts that the

underpayments in issue are due to petitioner's negligence or

disregard of rules or regulations. Sec. 6662(b)(1).

Negligence has been defined as the failure to do what a

reasonable and ordinarily prudent person would do under the

circumstances. Neely v. Commissioner, 85 T.C. 934, 947 (1985).

Respondent's determinations are presumed correct, and petitioner

bears the burden of proving otherwise. Rule 142(a); Luman v.

Commissioner, 79 T.C. 846, 860-861 (1982).

Petitioner was unable to provide substantiation for her

beginning and ending inventory values for her wholesale activity.

Further, petitioner was unable to provide substantiation for the
 - 14 -

majority of expenses she deducted on her Schedules C for 1993 and

1994. Petitioner had many years of experience in auditing and

accounting. Although she retained Mr. Baker to prepare her tax

returns, petitioner does not assert, and we do not find, that she

could reasonably rely on the advice of Mr. Baker as a basis for

not maintaining and keeping records to substantiate her inventory

balances or various business expense items. Therefore, we

sustain respondent's determination and hold that petitioner is

liable for the accuracy-related penalties.

Decisions will be entered

under Rule 155.