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.
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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.
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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
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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
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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
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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).
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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.