T.C. Memo. 2006-226
UNITED STATES TAX COURT
TOTAL HEALTH CENTER TRUST, BONNIE STEJSKAL, TRUSTEE, ET AL.,1
Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 8793-05, 8794-05, Filed October 24, 2006.
8795-05, 8796-05,
8797-05.
Joe Alfred Izen, Jr., for petitioners.
Sheila R. Pattison, for respondent.
1
The cases of the following petitioners were consolidated
for purposes of trial, briefing, and opinion: Country Rose
Holdings Trust, Bonnie Stejskal, Trustee, docket No. 8794-05;
Bio-Active Kansas Trust, Bonnie Stejskal, Trustee, docket No.
8795-05; Stejskal Enterprises Trust, Bonnie Stejskal, Trustee,
docket No. 8796-05; and Kenneth W. Stejskal, Sr. and Jane
Stejskal, docket No. 8797-05.
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MEMORANDUM OPINION
GOEKE, Judge: These cases arise from petitions for judicial
review filed in response to the notices of deficiency mailed to
Kenneth W. Stejskal, Sr. and Jane Stejskal and to several of
their trusts. Pursuant to a stipulation of settled issues, the
income and expenses of the alleged trusts have now been collapsed
into the tax liabilities of Kenneth and Jane Stejskal
(petitioners). The sole remaining issue for decision is the
proper amount of petitioners’ cost of goods sold in light of the
shrinkage to inventory suffered to the Kansas operation of their
dietary supplement business. We hold that while petitioners may
subtract the amount of product that is no longer saleable from
the ending inventory, they may not also add the same amount to
product purchases in calculating their cost of goods sold.
Background
These cases were submitted fully stipulated pursuant to Rule
122, and the facts are so found.2 The stipulations of facts and
the accompanying exhibits are incorporated herein by this
reference. At the time of the filing of the petitions,
petitioners resided in Corpus Christi, Texas.
2
Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended, and all Rule references
are to the Tax Court Rules of Practice and Procedure.
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Petitioners operate a business selling dietary supplements
and performing certain diagnostic services with operations in
both Kansas and Texas. The business first operated as a C
corporation and later as an S corporation. During the mid-1990s,
petitioners began reporting their business activities to the
Internal Revenue Service through a number of trusts including
Total Health Center Trust, Country Rose Holding Trust, Bio-Active
Kansas Trust, and Stejskal Enterprises Trust. In a stipulation
of settled issues reached with respondent, petitioners now
concede that these trusts should be disregarded for tax purposes,
and that all income attributable to the trusts is properly
reportable by petitioners on Schedule C, Profit or Loss From
Business, of their individual return.
For the 2000 and 2001 tax years, petitioners reported the
bulk of their business activities from both the Texas and Kansas
operations under the Stejskal Enterprises Trust (SET). SET
utilized a periodic inventory system. Petitioners’ accountant,
Janet Wilkerson, prepared separate trial balances for each of the
Texas and Kansas operations. Ms. Wilkerson also made adjusting
journal entries for each of the Kansas and Texas operations.
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The adjusting journal entries for the Kansas operation for
2000 include the following entry (adjusting journal entry 18):
Date Acct. No.# Debit Credit
12/31/00 Inventory 10500 $48,257.92
Product purchases 50000 $48,257.92
Ms. Wilkerson made this entry to adjust the Kansas inventory
account in accordance with the actual physical count of ending
inventory. The $48,257.92 is the difference between the trial
balance inventory of $171,448.06 and the physical count of
inventory of $123,190.14 and reflects the reduction of inventory
caused by the shrinkage, or spoilage, of SET’s products.
On the Schedule C attached to SET’s amended Form 1041, U.S.
Income Tax Return for Estates and Trusts, for the 2000 tax year,
petitioners reported the following amounts related to cost of
goods sold for the Kansas and Texas operations:
Beginning inventory (line 35) $221,908
Purchases (line 36) 414,832
Ending inventory (line 41) 207,516
Cost of goods sold (line 42) 429,224
The ending inventory amount of $207,516 reported on line 41 of
the Schedule C includes a reduction of inventory of $48,257.92
caused by shrinkage to the Kansas inventory and accounted for by
adjusting journal entry 18. The product purchases of $414,832
reported on line 36 of the Schedule C includes an increase to
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purchases of $48,257.92 from adjusting journal entry 18. The
amount of purchases before the effect of adjusting journal entry
18 is $366,574.08.
Discussion
This dispute centers on the proper treatment of petitioners’
cost of goods sold for the 2000 tax year. Petitioners maintain
that their business suffered shrinkage of inventory in the amount
of $48,257.92 and as a result the total cost of goods sold for
2000 is $429,224. Respondent concedes that petitioners are
permitted to adjust cost of goods sold by the amount of shrinkage
suffered.3 However, respondent maintains that petitioners are
double-counting the adjustment to cost of goods sold by including
the $48,257.92 in the line 36 purchases at the same time as
reducing the line 41 year end inventory by $48,257.92. Thus,
according to respondent, petitioners’ product purchases should be
$366,574 and petitioners’ cost of goods sold should be $380,966.
In order to compute the gross income of a business, gross
receipts are subtracted by the cost of goods sold. Sec. 1.61-
3(a), Income Tax Regs. Cost of goods sold, in turn, is computed
by subtracting the value of ending inventory for a year from the
sum of beginning inventory and purchases during that year. See
3
While not at issue here, we note that sec. 471(b) permits
estimates of inventory shrinkage that are confirmed by a physical
count after the close of the taxable year.
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Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 530 n.9
(1979).
In this case, petitioners used a periodic inventory system
which requires an adjustment to inventory at the end of the year
to reflect the physical ending inventory count. After performing
the physical count, petitioners’ accountant made an adjusting
journal entry for shrinkage, reflecting a $48,257.92 credit to
inventory and a $48,257.92 debit to product purchases.
Petitioners’ accountant then used the adjusting journal entry to
reduce the trial balance of petitioners’ yearend inventory by
$48,257.92 and at the same time to increase the trial balance of
petitioners’ product purchases by $48,257.92. The problem is,
there is nothing in the record to suggest, and petitioners do not
argue, that they actually purchased $48,257.92 of goods to
replace the inventory that was lost. And by including the
$48,257.92 adjustment in purchases as well as ending inventory,
petitioners increased their cost of goods sold reported on
Schedule C (and reduced gross income) by double the amount of
actual shrinkage their inventory suffered. Thus, while it was
proper to reduce the ending inventory by the amount of shrinkage,
it was improper for petitioners to also increase the line 36
product purchases by the same amount.
Accordingly, we find that petitioners’ product purchases for
2000 were $366,574, and their cost of goods sold was $380,966
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($221,908 + $366,574 - $207,516 = $380,966). To the extent an
accuracy-related addition to tax was once at issue, respondent
has stipulated that no addition to tax should be imposed with
respect to adjusting journal entry 18, and thus we do not
consider it.
To reflect the foregoing,
Decisions will be entered
under Rule 155.