Byrd v. Comm'r

T.C. Summary Opinion 2010-87

UNITED STATES TAX COURT

SHANNON B. AND RITA L. BYRD, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 24201-05S. Filed June 29, 2010.

Shannon B. Byrd and Rita L. Byrd, pro sese.

Beth A. Nunnink, for respondent.

CARLUZZO, Special Trial Judge: This case for the

redetermination of deficiencies was heard pursuant to the

provisions of section 7463.1 Pursuant to section 7463(b), the

1
Unless otherwise indicated, section references are to the
Internal Revenue Code of 1986, as amended, in effect for the
relevant period. Rule references are to the Tax Court Rules of
Practice and Procedure.
 - 2 -

decision to be entered is not reviewable by any other court, and

this opinion shall not be treated as precedent for any other

case.

In a notice of deficiency dated November 28, 2005,

respondent determined deficiencies in petitioners’ Federal income

taxes and penalties as follows:

Penalty
Year Deficiency Sec. 6662(a)

2002 $11,512 $1,391.60
2003 10,046 2,009.20
2004 11,359 -0-

The issues for decision are: (1) Whether for 2002

petitioners are entitled to a home mortgage interest deduction in

excess of the amount respondent allowed; (2) whether for 2004

petitioners are entitled to a depreciation deduction in excess of

the amount respondent allowed for a certain automobile awarded to

and used by Mrs. Byrd in connection with her trade or business;

(3) whether for 2002 petitioners are liable for the section 72(t)

additional tax with respect to a distribution from a qualified

retirement plan; (4) whether for each year in issue, petitioners

properly computed amounts shown for cost of goods sold and gross

income on a Schedule C, Profit or Loss From Business, included

with their joint Federal income tax return; and (5) whether for

2002 and/or 2003 petitioners are liable for a section 6662(a)

accuracy-related penalty.
 - 3 -

Background

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

Petitioners are, and were at all times relevant, married to each

other. They filed a joint Federal income tax return for each

year in issue. At the time the petition was filed, they resided

in Tennessee.

Mr. Byrd suffered a serious heart attack during 2002. After

recovering he resumed his full-time employment but, for health

reasons, terminated his part-time job. Before the close of 2002

he requested and received a $22,779 distribution from a qualified

retirement plan (the pension distribution). He was 51 years old

when he received the pension distribution.

In 2002, following Mr. Byrd’s heart attack, Mrs. Byrd,

concerned about the family’s loss of income, and “[seeing] an

opportunity to make some extra income”, became an “independent

[sales] consultant” for BeautiControl Cosmetics (BeautiControl).

As a BeautiControl consultant she purchased various cosmetic

products from the company for resale to her customers and engaged

in activities designed to encourage other individuals to become

BeautiControl sales consultants in a distribution network headed

by her. For the most part, her activities in connection with her

position with BeautiControl were conducted from her residence.

At some point between 2003 and 2004 there were 62 BeautiControl

consultants within her distribution network.
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As a result of her sales levels, BeautiControl awarded her

a 2004 red Ford Mustang convertible. She used the Mustang,

adorned with logos identified with BeautiControl, for

transportation to meet with prospective or existing customers, to

attend meetings and presentations, and to deliver products, all

in connection with her BeautiControl activities. BeautiControl

issued Mrs. Byrd a Form 1099-MISC, Miscellaneous Income, for 2004

reporting the value of the Mustang.

For each year in issue, petitioners reported the income and

expenses attributable to Mrs. Byrd’s BeautiControl activities on

a Schedule C included with their joint Federal income tax return.

The amounts shown for gross receipts, cost of goods sold, and

gross income on each Schedule C are as follows:

Year Gross Receipts Cost of Goods Sold Gross Income

2002 $12,522 $25,274 ($12,752)
2003 12,395 34,087 (21,692)
2004 41,116 13,324 27,792

The amounts shown as cost of goods sold were computed with

reference only to the total annual cost of the BeautiControl

products that she purchased for resale or promotional purposes.

Petitioners included the pension distribution in the income

reported on their 2002 joint Federal income tax return, but the

tax shown on that return does not include the section 72(t)

additional tax imposed on early distributions from qualified

retirement plans.
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On the Schedule A, Itemized Deductions, attached to their

2002 return, petitioners claimed a home mortgage interest

deduction of $15,102. Respondent received information from

petitioners’ mortgagee that indicated they paid $11,023 of

mortgage interest during 2002.

Petitioners included the value of the Mustang as shown on

the Form 1099-MISC in the income reported on their 2004 joint

Federal income tax return. On the Schedule C attached to that

return they claimed a $15,084 depreciation deduction attributable

to that car. The depreciation deduction is computed as though

the car was used 100 percent in Mrs. Byrd’s BeautiControl

activity and eligible for a special depreciation allowance

discussed infra.

In the above-referenced notice of deficiency, respondent:

(1) Disallowed $4,079 of the mortgage interest deduction claimed

on the Schedule A included with petitioners’ 2002 return; (2)

disallowed a portion of the depreciation deduction claimed on the

Schedule C included with petitioners’ 2004 return; (3) increased

petitioners’ 2004 tax liability by imposing the section 72(t)

additional tax on the pension distribution; (4) adjusted the

amounts shown for cost of goods sold and gross income shown on

the Schedule C included with petitioners’ return for each year in

issue; and (5) imposed a section 6662(a) accuracy-related

penalty on various grounds for 2002 and 2003.
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Discussion

I. Disallowed Deductions

Two of the issues listed above involve deductions, portions

of which have been disallowed, and we turn our attention first to

those issues.

Respondent’s determinations, having been made in a notice of

deficiency, are presumed correct, and petitioners bear the burden

of proving those determinations to be erroneous. See Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Their

burden of proof includes establishing both the right to and the

amount of any deduction claimed. See Rule 142(a); INDOPCO, Inc.

v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v.

Helvering, 292 U.S. 435, 440 (1934); Welch v. Helvering, supra.

This includes the burden of substantiation. See Hradesky v.

Commissioner, 65 T.C. 87, 90 (1975), affd. per curiam 540 F.2d

821 (5th Cir. 1976).

A. Home Mortgage Interest Deduction

In general, a taxpayer is entitled to a deduction for

qualified residence interest (referred to on the Schedule A as

“Home mortgage interest”). Sec. 163(a), (h)(2)(D). Taxpayers

must be able to substantiate the amount claimed. See sec. 6001;

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

Respondent disallowed $4,079 of the $15,102 home mortgage

interest deduction petitioners claimed on their 2002 return for
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lack of substantiation. Petitioners have failed to establish

that they are entitled to a deduction for home mortgage interest

in excess of the amount respondent allowed.

B. Depreciation of Mustang

Section 168(k)(4) provides for an additional depreciation

deduction (bonus depreciation) of 50 percent of the adjusted

basis of qualified property. Qualified property is defined as

property that meets the following requirements: (1) The property

was MACRS property with an applicable recovery period of 20 years

or less, unless it was certain computer software, water utility

property, or qualified leasehold improvement property; (2) the

original use of the property commenced with the taxpayer after

May 5, 2003; (3) the taxpayer acquired the property after May 5,

2003, and before January 1, 2005; and (4) the taxpayer placed the

property in service before January 1, 2005. Sec. 168(k)(4).

On the Form 4562, Depreciation and Amortization, attached to

their 2004 tax return, petitioners claimed a $12,570 special

depreciation allowance and an MACRS bonus depreciation deduction

of $2,514, for a total of $15,084. The entire amount of the

depreciation deduction reported on the Schedule C is attributable

to the 2004 Ford Mustang.

Respondent contends that petitioners are not entitled to a

section 168(k) bonus depreciation deduction because the Mustang

fails to meet the definition of qualified property under section
 - 8 -

168(k). Furthermore, respondent argues that the Mustang is

listed property within the meaning of section 280F(d)(4)(A)(i)

and therefore does not qualify for the bonus depreciation

afforded by section 168(k).

If any listed property is not predominantly used in a

qualified business, the alternative depreciation system under

section 168(g) must be used to calculate the depreciation

deduction. Sec. 280F(b)(1). Property is treated as

predominantly used in a qualified business if the business use

exceeds 50 percent. Sec. 280F(b)(3). Section 168(k) excepts

from the bonus depreciation allowance any property to which the

alternative depreciation system under section 168(g) applies,

unless the taxpayer elected to use the alternative depreciation

system.

The Mustang is MACRS property with an applicable recovery

period of 5 years and was acquired and placed in service during

the applicable periods. Petitioners allege that the Mustang was

used almost exclusively for business purposes, and we agree.

Although the Mustang is listed property under section 280F(d)(4),

it was used predominantly for business purposes and therefore it

is not subject to section 168(g). Accordingly, petitioners’

Mustang satisfies the definition of qualified property within the

meaning of section 168(k)(2)(A).
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Petitioners have satisfied the requirements of section

168(k) and therefore are entitled to the bonus depreciation

afforded by section 168(k)(4), limited only by section

280F(a)(1)(A)(i).

II. Early Distribution Pursuant to Section 72(t)

Generally, amounts distributed from “a qualified retirement

plan (as defined in section 4974(c))” are includable in gross

income as provided in section 72. Sec. 408(d)(1). A 10-percent

additional tax is imposed under section 72(t) on any distribution

that fails to satisfy one of the exceptions for premature

distributions as provided in section 72(t)(2). This Court has

consistently held that it is bound by the list of statutory

exceptions. See, e.g., Arnold v. Commissioner, 111 T.C. 250, 255

(1998); Schoof v. Commissioner, 110 T.C. 1, 11 (1998); Clark v.

Commissioner, 101 T.C. 215, 224-225 (1993).

Petitioners agree that the pension distribution was made

from sources contemplated by section 72(t). They argue that the

additional tax does not apply because they used the distribution

to supplement the income from Mr. Byrd’s second job that he “no

longer was able to do because of illness”. The “illness” to

which petitioners refer is the heart attack referenced above.

Section 72(t)(2)(A)(iii) provides an exception for

distributions to disabled taxpayers (within the meaning of

section 72(m)(7)) to which the 10-percent additional tax does not
 - 10 -

apply. Section 72(m)(7) provides that an individual is

considered disabled if: (1) He is “unable to engage in any

substantial gainful activity by reason of any medically

determinable physical or mental impairment”, and (2) the

disability “can be expected to result in death or to be of long-

continued and indefinite duration.” See Dwyer v. Commissioner,

106 T.C. 337 (1996). Under section 72(m)(7), the taxpayer must

furnish proof of the aforementioned elements. Section 1.72-

17A(f)(2), Income Tax Regs., provides that the determination is

to be made on the basis of all the facts and includes a list of

nonexclusive examples of impairments that would ordinarily be

considered as preventing substantial gainful activity.

Petitioners have failed to substantiate Mr. Byrd’s condition

with a physician’s note or other evidence detailing his

disability. He was able to return to his full-time employment

after recovering from his heart attack. Therefore, we conclude

that any disability Mr. Byrd suffered as a result of his heart

attack in 2002 did not render him “disabled” within the meaning

of section 72(m)(7). Accordingly, petitioners are liable for the

10-percent additional tax on an early distribution pursuant to

section 72(t) in 2002.

III. Schedule C Items--Gross Receipts and Cost of Goods Sold

Respondent determined deficiencies in petitioners’ Federal

income taxes for 2002 and 2003 due to understatements of gross
 - 11 -

receipts from Mrs. Byrd’s Schedule C business and miscalculations

of cost of goods sold. In general, petitioners argue that no

such understatements and miscalculations exist.

A. Cost of Goods Sold

Petitioners reported cost of goods sold on their Schedules C

of $25,274, $34,087, and $13,324 on their 2002, 2003, and 2004

returns, respectively. In the notice of deficiency respondent

determined that petitioners overstated cost of goods sold in 2002

and 2003 and understated cost of goods sold in 2004.

Petitioners acknowledge that they failed to take inventories

into account in the calculation of cost of goods sold shown on

the Schedule C for each year in issue. According to petitioners,

the amounts shown on the Schedules C consist merely of the total

of the purchases made during each year.2

The parties now agree that the amounts shown for cost of

goods sold on the Schedules C, as well as the adjustments made to

these items in the notice of deficiency, are incorrect. They

further agree that the purchases total $4,748, $34,359.86, and

$18,778.53 for 2002, 2003, and 2004, respectively. The record

leaves us no choice but to assume that all items purchased during

2
In the case of “businesses that sell a large number of
essentially similar or fungible items” the cost of goods sold is
computed in steps, using inventories and an accrual method of
accounting, as follows: Beginning inventory + purchases - ending
inventory = cost of goods sold. See Gertzman, Federal Tax
Accounting, par. 6.02[2], at 6-5 to 6-6 (2d ed. 1993).
 - 12 -

any year were sold before the close of that year; at least

nothing in the record suggests otherwise. That being so, the

total purchase amounts would, in effect, reflect the cost of

goods sold for each year. Therefore, we find that the Schedules

C cost of goods sold for 2002, 2003, and 2004 should be $4,748,

$34,359.86, and $18,778.53, respectively.

B. Understatements of Income

Section 446(b) allows respondent to recompute petitioners’

income “under such method as, in the opinion of the Secretary,

does clearly reflect income” if petitioners’ method does not

clearly reflect income. The percentage or markup approach is an

acceptable method under section 446(b) to recompute income in

certain businesses, including petitioners’ merchandising

business. Webb v. Commissioner, 394 F.2d 366, 373 (5th Cir.

1968), affg. T.C. Memo. 1966-81; Bernstein v. Commissioner, 267

F.2d 879 (5th Cir. 1959), affg. T.C. Memo. 1956-260.

In the notice of deficiency respondent adjusted gross

receipts for each of the taxable years in issue to reflect the

average 50-percent markup for BeautiControl. In the notice of

deficiency respondent calculated gross receipts by increasing the

determination of cost of goods sold by 50 percent.

According to petitioners, respondent’s calculation of gross

receipts does not accurately reflect the amount of unreported

income for the years in issue because it fails to consider gifts
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and promotional materials given away. Theoretically, their point

is well made. But their failure to keep or produce any records

that quantify such gifts and giveaways compels us to ignore their

generalized claim. Gross receipts attributable to Mrs. Byrd’s

Schedule C business shall be determined as computed by the method

advanced by respondent but only after taking into account the

above-found amounts for cost of goods sold.

IV. Section 6662(a) Accuracy-Related Penalty

For each of the years 2002 and 2003 respondent determined

that petitioners are liable for a section 6662(a) accuracy-

related penalty. Various grounds for the imposition of that

penalty are set forth in the notice of deficiency. The

Commissioner has the burden of production to show imposition of

the penalty is appropriate; but if it is shown that the taxpayer

acted in good faith and there is reasonable cause for the

deficiency, then the section 6662(a) accuracy-related penalty is

not applicable. Secs. 6664(c), 7491(c); Higbee v. Commissioner,

116 T.C. 438, 446-447 (2001).

Petitioners relied upon a paid income tax return preparer to

compute their Federal income tax liability shown on their joint

return for each year in issue. Given their backgrounds, we are

satisfied that their reliance on their return preparer was

reasonable. We are further satisfied that petitioners had

reasonable cause and acted in good faith with respect to whatever
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deficiency remains after respondent’s concessions and the

foregoing determinations for each year in issue are taken into

account. They are not liable for the section 6662(a) accuracy-

related penalty for any year in issue.

To reflect the foregoing,

Decision will be entered

under Rule 155.