Shannon B. & Rita L. Byrd, Petitioner

UNITED STATES TAX COURT

SHANNON B . ANDRITA L . BYRD, Petitioners v, COMMISSIONER OF INTERNAL REVENUE, Responden t Docket No . 24201-055 .

Filed June 29, 2010 .

CARLUZZO, Special Trial'Judcre : This case for the redetermination of deficiencies was . heard pursuant to the provisions of section 7463 .1 Pursuant to section 7463(b), th e '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 .

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 :

Year Deficiency 2002 2003 2004 $11,512 10,046 11,359 Penalt y Sec . 6662(a ) $1,391 .6 0 2,009,2 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 200 4 petitioners are entitled to a`depreciation deduction-in excess o f 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 qualifie d retirement plan ; (4) whether for each'year in issue, petitioner s properly computed amounts shown for cost of goods sold and gross income on a Schedule C, Profit or Loss From Business, include d 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 .

Backgroun d 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 reside d in Tennessee .

Mr . Byrd suffered a serious heart attack during"2002 . After recovering he resumed his full-time employment but, for . healt h reasons, terminated his part-time job . . 'Before . the close of52002 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,,- concerne d concerned about .the family's loss .of .income, and "[seeing-] a n 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 sale's 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 BeautContro l P consultants within her distribution network .

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

The amounts shown for gross,receipts,~cost-of goods sold, an d gross income on each Schedule C are as follows :

Year 2002 : 2003 2004 Gross Receipts . Cost of Goods Sold ..

Gross Incom e $12,52 2 12,395 41,116 $25,27 4 34,087 13,32.4 ($12,752 ) (21,692 ) 27,79 2 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 .,promotionalpurposes .

, 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 distr-ibutions from qualified retirement plans .

On the Schedule A, Itemized Deductions, attached to their 2002 , return, petitioners claimed a homemortgage . interest .- deduction of $15102 .

Respondent "received information fro m etitioners ' mortgagee that indicated `-they-naid $11023 o f mortgage interest during 2002 .

Petitionerstincluded the-value ofl .the .Mustang as shown on ..the Form 1099-MISC inthe .income reportedaon their .2004 joint''- Federal income tax return . -On theSchedule-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°-BeautiContro l activity .and,,eligiblefor .aspecial 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 depreciationdeduct,ion',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 'di'stribution ; °(4) adjusted the amounts shown for cost of goods 'sold and=gross income shown=°on .F .

the Schedule C included with petitioners' return ..for".each year in issue ; and' (5) imposed a-section 6662(a)',accuracy-relate d penalty on various grounds for 2002 .and .2003 .

I .

Disallowed Deductions .

Discussion .

Two of the issues listed above involve . deductions, . . portions,,,, of which . have been 'disallowed, and ..we turn our ;attention first t o those issues .

Respondent's determinations, having been made . jn(cid:127)a notice o f 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 .

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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 . Helverina , supra .

This includes the burden of°,substantiation .- See= Hradesky v .

Commissioner , 65 T .C .(cid:127) 87 90 (1975) affd .=°per curiam ., 540 F .2 d 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 Aas "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, .

lack of 'substantiation' . ' Petitioners have failed to establish that they are entitled-to a-deduction for home mortgage-"interes t in excess of . the amount respondent . allowed.

B .

Depreciation of Mustan g Section 168 (k) (4) provides -for ian additional depreciatio n 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 j'an applicable recovery per-iod of~ 20 year s or less, unless it was certainxcomputer software, water utility property, or qualified lea'sehold`improvement property ; (2) the original use of the property commenced` with the 'taxpayer afte r 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 Forin 4562, Depreciation and'Amortization, attached to their 2004 tax return, petitioners claimed a-'$12,570 special depreciation allowance and an MACRS?bonus depreciation deductio n of $2,514, for a total of $15,"084 . The entire :amount of the , depreciation deduction reported 'on the'ScheduleC isattributabl e to the 2004 Ford Mustang :

Respondent contends that petitioners are not-entitled-t o section 168(k bonus depreciation deduction-because the Mustang fails to meet the definition of qualified property under section, 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 unde r 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 .us e exceeds 50 percent . Sec . 280F :(b),,(3) . Section 168(k) except s from . the bonus depreciation allowance any, property to,which the .

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alternative!depreciation s Y stem -under section168(g) applies , unless'the taxpayer elected to use the alternative depreciation system .

The .Mustang is MACRS property with an applicable recovery period of⁵ years and was acquired and placed .-in service during the applicable periods .

.Petitioners allege that the . Mustangwa s 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 th e meaning of section -1_68,()S) µ (2) ..(_A) Petitioners` have satisfied the requirements ofsection 168(k) and therefore-are entitled to the bonus depreciation afforded by .section 168 .(k) (4) , limited-only by sectio n 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 A 10-percent additional tax is imposed under section 72(t)-on any distribution that fails to satisfy .one_of theexceptions for premature distributions -as provided :in section 72 (t) (2) . This Court .has° consistently held that its bound"by . .the .list of statutory exceptions .,' See, e .g .,,: Arnold v . C.ommissioner ,,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'sapply`because they used(cid:127)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" t o which petitioners refer is the heart attack-referenced above .__ Section 72 (t)(2) (A) (iii) provides an .-exception- for::

distributions todisabled taxpayers .(within the .meaning"of section 72(m)(7)) to which the 10 percent additional tax does not apply . Section 72 ( m)(7) ; .`provide s considered- :disabled ,if (1') He "is "unable to engage `i n substantial gainful -activity .. by reason,, of any medically ; w determinable. physical or mental : impairment", and .(2) ° disability "can b;e ,expected --to ._ result Tin death,-o"r. %t"o continuedaid :indef-inite duration 106 T . C :.

furnish Under section 72 (m)_ (7) ; . th e 17A(f) ( 2) Income Tax Reg .s, .

to be made . on,Athe basis . :of, .:all-°,the .,facts and,,includes ..a fis t nonexclusive examples=o f impairments . that ...would ordinarily, .:be :

lvltyy ., Petitioners have, failed to substantiate~Mr . Byrd' s with ` a . physician' s note or , other .=evidence detailing hi s disability .

He was able ,to :return his,full 'time after re cove ring . from .: his heart-attack . ,, , Therefore ,,_ we that, any. fdisabilitySMr . .

;:Byrd suffered as -a,, result -of hi s attack-In 2002°did<not render~hm " :disabled"*within the meaning section X⁷² (m)-M, .- Accordingly, petitioners ,are liable for the, .

10-percent additional tax .on-an .early distribution section 72 (t) in 2002 .

III . Schedule C Items--Gross Receipts . ;and .Cost, of Goods Sol d Respondent determined deficiencies in ;pe~titioners' Federal income taxes for 2002 , and .2003, due to" :understatements of :gross-, receipts from Mrs . Byrd's ScheduleCbusiness°and miscalculations of cost of goods sold . In general petitioners argue that n o .such understatements and miscalculations exist .

Cost of Goods Sol d Petitioners reported'cost of goods sold onttheir 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- soldin 2004- .

Petitioners acknowledge that they failed to take-inventories .

into -account in the calculation''of`cost `of goods -sold shown on the Schedule .Cfor 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 .

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The parties now agree that : the amounts shown-for cost of goods sold on ,the Schedules '-C, as well . as `the adjustments made t o these items°in`the . notice of'deficiiency , . are incorrect .' The y 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 21n-the case of "businesses that sell a large number, essentially similar or fungible items" the cost of goods sold is computed ;in .steps,,usinginventories 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) .

1 2 any , year .were sold before .the close, of that year ; , at ,leas t nothing in the record suggests otherwise . That being so, the .

total purchase amounts would, in effect, reflect the cost o f goods sold for each year .

Therefore , we find that the .-Schedule s C cost of goods ..,sold for, 2002, 2003, and 2,004 should be $4,748 , $34,359 .86,, and $18,778 .53, . respectively .

B Understatements of Incom e 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 no t clearly reflect income . The percentage or markup approach is an acceptable method under section 446(b) to recompute income .'i n .certain businesses, including petitioners' ;,merchandisin g business .

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

1968) ;, affg .T. .,,C . Memo . 1966-81 ; Bernstein v . Commissioner , .26 7 F .2d 879 (5th Cir . 1959), .,, affg . . T .C . .Memo . 19561-260 ., .

In the notice of deficiency respondent adjusted gros s receipts for each of the .taxable years in issue to reflect th e average 50-percent markup for BeautiControl . In the notice o f by increasing .th e 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 13 - and : promotional„ materials given .away, . Theoretically= their= point is well made . ; But : their failure to-keep or produce,-any record s that quantify s~ch gifts and giveaways comels us to ignore thei r generalized claim . Gross receipts attributable to Mrs . Byrd's Schedule C business shall be determined as .computed by the metho d advanced by respondent but only after taking into account th e IV .

Section 6662(a) Accuracy-Related Penalt y For each of the years 2002 and 200 .3 respondent determine d 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 . Th e Commissioner has the burden of production to show-impositionof the penalty is appropriate ; but if it is shown that the taxpayer acted in good faith and there is reasonable cause for th e 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) .

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Petitioners relied upon a paid income tax return preparer to compute their Federal income tax liability shown on their join t 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 ha d reasonable cause and acted in good faith with respect to whatever deficiency ; remains wafter respondent' s "concessions'° and, th e foregoing determinations, for ;each(cid:127) year in issue are, . taken- into account- ., -,:They'are not :liable .for ,tYie'section 666 .2 (a) .^ accuracy- related`>penalty .for ahy.,year . in `issue .

To-'"refle.ct,~ the .:-foregoing., :

i under Rule°155