Taxpayers Deny Unreported Income.
Carney, James P., et ux. v. Commissioner
- CourtUnited States Tax Court
- DocketDocket No. 11248-93
- AuthorsGriffin, William F., Jr.
- Code Sections
- Jurisdictions
- LanguageEnglish
- Tax Analysts Document NumberDoc 93-75171
- Tax Analysts Electronic Citation93 TNT 148-66
Carney, James P., et ux. v. Commissioner
JAMES P. AND LINDA F. CARNEY,
Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
====== SUMMARY ======
James and Linda Carney are denying the IRS's determination that they had unreported income from various sources in 1989, including unexplained bank deposits, consulting income, rental income, dividend income, and distributive income from various S corporations.
The couple also is disputing the denial of various business expense and depreciation deductions as well as the disallowance of a capital loss carryforward.
Period and Amount at Issue: 1989 -- $372,617 plus $74,523 in penalties
Code Section Classification: 61, 162, 167, 1212, 6662
====== FULL TEXT ======
PETITION OF JAMES P. CARNEY
The petitioner hereby petitions for redetermination of the deficiency set forth by the Commissioner of Internal Revenue in his notice of deficiency dated March 9, 1993 and as a basis for his case alleges as follows:
1. Petitioner James P. Carney is a Massachusetts resident with a present address at 117 Jacob Amsden Circle, Westborough, Massachusetts 01581. The joint return for the period here involved was filed by the petitioner and his then-spouse, Linda F. Carney, with the office of the Internal Revenue Service at Andover, Massachusetts, using Mr. Carney's taxpayer identification number 022-38-6001.
2. The notice of deficiency (a copy of which, including so much of the statement and schedules accompanying the notice as is material, is attached and marked Exhibit A), was mailed to the petitioner on March 9, 1993 and was issued by the District Director, Boston, Massachusetts.
3. The deficiencies as determined by the Commissioner are in income taxes for the calendar year 1989 in the amount of $372,617, all of which are in dispute.
4. The determination of tax set forth in said notice of deficiency is based upon the following errors:
(a) The Commissioner erred in determining that the
petitioner received additional income in the amount of $389,293
in calendar year 1989 which he failed to include on his income
tax return.
(b) The Commissioner erred in determining that the
petitioner did not incur a loss on the complete liquidation of
Carney Buick, Inc. in calendar year 1987, since a complete
liquidation did not take place in that year, and therefore the
$5,335 capital loss carryforward claimed by petitioner for 1989
was not an allowable deduction.
(c) The Commissioner erred in determining that the
petitioner received $75,938 in consulting income in calendar
year 1989 which he failed to report on his income tax return.
(d) The Commissioner erred in determining that petitioner
received additional rental income in the amount of $137,000 in
calendar year 1989 which he failed to report on his income tax
return.
(e) The Commissioner erred in determining that Boston Car
Company, Inc., d/b/a Acura of Boston, is not eligible as a
Subchapter S corporation and that petitioner's taxable income
for calendar year 1989 should be reduced by $73,392.
(f) The Commissioner erred in determining that the
petitioner received dividend income of $40,166 in calendar year
1989 from Boston Car Company, Inc. ($34,928) and Carney
Management Co., Inc. ($5,238) which he failed to report on his
income tax return.
(g) The Commissioner erred in determining that the
petitioner's distributive share of S corporation income from
Bernardi Cycles, Inc. for calendar year 1989 should be increased
by $682,002.
(h) The Commissioner erred in determining that the
petitioner's distributive share of S corporation income of
Bernardi's, Inc. d/b/a Bernardi Honda for calendar year 1989
should be increased by $531,547.
(i) The Commissioner erred in determining that the
petitioner's distributive share of S corporation income of Crown
Chevrolet Trust for calendar year 1989 should be decreased by
$317,682.
(j) The Commissioner erred in determining that the
petitioner's distributive share of S corporation income of Crown
Oldsmobile Toyota Trust for calendar year 1989 should be
decreased by $229,292.
(k) The Commissioner erred in determining that the
petitioner's distributive share of S corporation income of
Norwell Cars, Inc. for calendar year 1989 should be increased by
$89,860.
(l) The Commissioner erred in determining that all or a
portion of the underpayment of income taxes for the calendar
year 1989 is due to negligence or intentional disregard of rules
and regulations.
(m) The Commissioner erred in imposing an accuracy-related
penalty for calendar year 1989 under Section 6662(a) of the
Internal Revenue Code.
5. The facts upon which the petitioner relies, as the basis for his case, are as follows:
A. Other Income
1. The Commissioner determined that checks totalling
$389,293 deposited to James Carney's bank accounts at The
First National Bank of Boston in 1989 were income in that
year.
Date Amount
---- ------
5/12/89 10,000.00
3/6/89 8,636.00
7/20/89 1,165.00
6/16/89 301,328.00
11/16/89 68,164.00
-----------
$389,293.00
===========
2. The amounts in question represent non-taxable S
corporation distributions, taxable income reported by the
petitioner on his Federal income tax return, taxable income
adjusted elsewhere by the Commissioner, transfers of funds
between bank accounts, sales of assets offset by basis,
refunds of amounts escrowed by the petitioner and
repayments of amounts advanced by the petitioner to third
parties.
B. Capital Loss on Liquidation of Carney Buick.
(a) Carney Buick, Inc. sold substantially all of its
assets to Prestige Buick, Inc. in March 1987. In connection
with this transaction, all of the assets of Carney Buick
(after payment of its liabilities) were distributed to Mr.
Carney, its sole shareholder. As a result, Mr. Carney
recognized a $112,273 loss, measured by the difference
between his basis in his stock ($125,000) less the
liquidation proceeds ($12,727). A portion of that loss
($5,335) was carried over to 1989.
(b) The Commissioner determined that the liquidation
was not "complete", since the stock was not surrendered and
the corporation remained in existence. Accordingly, he
disallowed the loss on the transaction.
(c) The Commissioner's determination is in error
because a dissolution of the corporation and a physical
surrender of stock certificates are not prerequisites for a
complete liquidation under the Code.
(d) In the alternative, petitioner states that the
basis in the Carney Buick stock held by him will be
affected by his distributable share of S corporation income
from that corporation as to which many adjustments are
proposed.
C. Consulting Income
1. On December 31, 1986, James Carney signed a
Consulting Agreement in connection with the sale of the
assets of Carney Buick, Inc. The agreement called for
payments for $20,000 per quarter for five years.
2. Petitioner admits that he received $75,938 in
consulting income for 1989.
3. Petitioner states that the amounts in question were
reported by him as income on his 1989 Federal income tax
return.
4. Petitioner further states that the adjustments
proposed by the Commissioner duplicate other adjustments
made by the Commissioner.
D. Rental Income
1. In 1989, petitioner leased property in Natick,
Massachusetts to Bernardi Cycles, Inc. and Bernardi's, Inc.
Bernardi Cycles, Inc. paid rent to petitioner of $151,500
and Bernardi's, Inc. paid rent in 1989 of $272,000.
Petitioner reported a total of $316,500 in rent from the
Natick properties.
2. The amount of $30,000 included in the notice of
deficiency was paid to "Canary Realty Co.", an entity
entirely unrelated to the petitioner, and is therefore not
taxable income to the petitioner.
3. The additional $107,000 in rent was unreported by
Mr. Carney.
E. Distributive Share: Boston Car Company
1. Boston Car Company, Inc. ("Boston Car Company") is
a Massachusetts corporation wholly owned by Mr. Carney and
a grantor trust. It operates an Acura dealership in
Brighton, Massachusetts, under the name "Acura of Boston".
Boston Car Company, Inc. filed an S corporation election on
January 17, 1986 and filed income tax returns on Form 1120S
reporting $79,392 as Mr. Carney's distributive share of the
corporation's income for 1989.
2. Boston Car Company's S corporation election was
reviewed and approved by the IRS in connection with its
examination of that corporation. The IRS agent stated that
"No problems were [sic] noted with the election, it is
accepted as provided."
3. Since Boston Car Company is a valid S corporation,
the petitioner must report his distributive share of net
income from that corporation.
F. Dividend Income
1. In 1989, Boston Car Company made payments to or for
the account of Mr. Carney which the Commissioner
characterized as dividend distributions rather than
distributions of previously taxed S corporation income:
Various personal expenses $29,740.00
Personal travel expenses 5,188.00
----------
$34,928.00
==========
2. Since Boston Car Company is an S corporation, any
distributions to shareholders were distributions from S
corporation income and are therefore not taxable to Mr.
Carney.
3. In the alternative, the expenses incurred by Boston
Car Company constituted ordinary and necessary business
expenses incurred in the ordinary course of its business,
rather than distributions to shareholders.
4. In the alternative, even if the expenses in
question are not deductible by Boston Car Company because
they were made on account of expenses of other related
taxpayers, then a corresponding deduction should be allowed
to the related taxpayer. As a consequence of said
deduction, the petitioner's share of distributable S
corporation income from such other corporation should be
correspondingly reduced.
G. Distributive Share - Bernardi Cycles
Bernardi Cycles, Inc. ("Bernardi Cycles") is a
Massachusetts corporation wholly-owned by James Carney. During
the period in question, it operated a motorcycle, all-terrain
vehicle, snowmobile and other small engine products dealership
in Natick, Massachusetts. It filed an income tax return as an S
corporation on Form 1120S for calendar year 1989.
The total proposed adjustment for 1989 is $682,002;
summarized as follows:
1. Inventory Reserve $339,365
2. Non-Auto Inventory Cap. 82,560
3. Unapplied Labor 4,000
4. Other Expenses 6,517
5. Repossessions Receivable 71,347
6. Other Income 11,798
7. Miscellaneous Deductions 153,483
8. Depreciation Expense 12,932
--------
$682,002
========
G-1 Inventory Reserve
(a) In 1989, Bernardi Cycles charged $339,365
against cost of goods sold "to provide inventory
writedown estimated out on half of cost."
(b) The Commissioner determined that no support
for this deduction was provided and that it
represented an "inventory reserve."
(c) The amount deducted represents an ordinary
and necessary business expense or loss incurred during
the liquidation of Bernardi Cycles' business.
G-2 Non-Auto Inventory Cap
(a) In 1989, Bernardi Cycles charged cost of
sales with $82,560 in non-auto inventory "to adjust
for capitalized inventory expense W/O."
(b) The Commissioner determined that no support
was provided for this entry.
(c) The amount deducted represents an ordinary
and necessary business expense or loss incurred during
the liquidation of Bernardi Cycles' business.
G-3 Unapplied Labor
(a) In 1989, Bernardi Cycles reduced work in
process by $4,000 and debited Account 657 (Unapplied
labor) by the same amount.
(b) The amount deducted represents an ordinary
and necessary business expense or loss incurred during
the liquidation of Bernardi Cycles' business.
G-4 Other Expenses
(a) The Commissioner determined that numerous
deductions taken by Bernardi Cycles totalling $6,517
for 1989 should be disallowed, for various reasons,
summarized below:
6/19/89 Herald & Ann Kern $1,221.25 (d)
5/25/89 Bernardi Cycles 5,295.26 (g)
---------
$6,516.51
=========
Key
---
(a) Capitalized leasehold improvement
(b) Capitalized equipment
(c) Non-deductible, not this taxpayer's expense
(d) Unallowable deduction, substantiation, etc.
(e) Capitalized furniture and fixtures
(f) This payment was subsequently determined not to be
an expense by the IRS and was refunded, no record
of the refund has been found and therefore it is
disallowed in full until such a record is
produced.
(g) Check to the company offset by unidentified
receipt
(b) Each of the foregoing payments were made on
account of ordinary and necessary business expenses
incurred by Bernardi Cycles in the ordinary course of
business.
(c) In the alternative, if it is determined that
any of said payments were not properly deductible by
Bernardi Cycles because they were made on account of
expenses of other related taxpayers, then a
corresponding deduction should be allowed to the
related taxpayer. As a consequence of said deduction,
the petitioner's share of distributable Subchapter S
income from such other corporation should be
correspondingly reduced.
G-5 Repossessions Receivable
(a) During 1989, Bernardi Cycles liquidated its
cycle business. In connection therewith, $71,347 in
accounts receivable from repossessions were written
off as worthless.
(b) The Commissioner determined that no specific
receivables were identified as worthless and therefore
Bernardi Cycles had created a bad debt reserve
contrary to the Code.
(c) The accounts receivable in question were
determined by Bernardi Cycles to be worthless on a
case-by-case basis in connection with the liquidation
of its business and are properly deductible as an
ordinary and necessary business expense.
G-6 Other Income
(a) In 1989, Bernardi Cycles wrote off $11,798 in
finance income receivable.
(b) The amounts written off represent offsets and
chargebacks asserted by banks, finance companies and
others and represent ordinary and necessary business
expenses of Bernardi Cycles.
G-7 Miscellaneous Deductions
(a) (i) During 1989, Bernardi Cycles liquidated
its cycle business.
(ii) Some $33,920.35 in Honda cycle inventory was
written off as a miscellaneous inventory expense and
Honda floor plan financing was increased by $62,221.21
as an additional miscellaneous expense.
(iii) The amount deducted represents an ordinary
and necessary business expense or loss incurred during
the liquidation of Bernardi Cycles' business.
(b) (i) During 1989, Bernardi Cycles wrote off
$1,410.68 in advances on pay and $3,967.90 in company
demos.
(ii) The Commissioner determined that no support
existed for this deduction.
(iii) The amount deducted represents an ordinary
and necessary business expense or loss incurred during
the liquidation of Bernardi Cycles' business.
(c) (i) In 1989, Bernardi Cycles wrote off
$35,843.70 in accounts receivable as miscellaneous
deductions.
(ii) The Commissioner determined that no specific
account was determined to be worthless and no event
causing the worthlessness of all accounts had
occurred.
(iii) The amount deducted represents an ordinary
and necessary business expense or loss incurred during
the liquidation of Bernardi Cycles' business.
(d) (i) In 1989, Bernardi Cycles wrote off
$8,079.10 in accounts receivable.
(ii) The Commissioner determined that no specific
account had become worthless and no event had occurred
causing the worthlessness of all accounts.
(iii) The amount deducted represents an ordinary
and necessary business expense or loss incurred during
the liquidation of Bernardi Cycles' business.
(e) (i) In 1989, Bernardi Cycles wrote off
$8,038.28 in its gas, oil and grease account.
(ii) The Commissioner determined that no
substantiation existed for this deduction.
(iii) The amount deducted was properly documented
and represents an ordinary and necessary business
expense or loss incurred during the liquidation of
Bernardi Cycles' business.
G-8 Depreciation Expense
(a) Reduction of depreciable assets.
(i) The Commissioner has disallowed
depreciation on the following assets placed in
service in 1988: machinery and equipment
($7,270), company vehicles ($44,100) and
leasehold improvements ($3,010).
(ii) The 1988 Bernardi Cycles fixed asset
additions are correctly stated.
(iii) In the alternative, any expenditure
that is not classified by the Commissioner as a
fixed asset is allowable as an ordinary and
necessary business expense incurred in Bernardi
Cycles' trade or business.
(b) Depreciation on expenditures capitalized by
the Commissioner.
(i) The Commissioner has recharacterized
certain expenses as capital items as follows:
1987 1988
---- ----
Leasehold improvements $ 3,706 $-0-
Equipment 13,716 2,370
Furniture and fixtures 1,145 -0-
(ii) The Commissioner has calculated
depreciation expense allowable with respect to
the capitalized expenses.
(iii) The expenses are ordinary and
necessary business expenses incurred in the
course of Bernardi Cycles' trade or business.
(iv) In the alternative, the expenditures
are either equipment or furniture and fixtures,
and not leasehold improvements.
H. Distributive Share - Bernardi Honda
Bernardi's, Inc. d/b/a Bernardi Honda ("Bernardi Honda") is
a Massachusetts corporation wholly owned by Mr. Carney. It
operates a Honda dealership in Natick, Massachusetts. It filed
an income tax return as an S corporation on Form 1120S for
calendar year 1989.
The total adjustments proposed are $531,547, summarized as
follows:
1. Professional fees $125,000
2. Interest income 34,491
3. Depreciation expense (6,342)
4. Cost of goods sold 90,000
5. Other expenses 241,657
6. Temp. and cont. services expense 46,741
--------
$531,547
========
H-1 Professional Expense
(a) In Bernardi Honda's accountant's year-end
journal entries for 1989, the sum of $124,999.92 was
reclassified as "temporary and contract services."
(b) The journal entry in question represents
merely a reclassification of expenses and does not
affect the profit or loss or taxable income of the
business.
H-2 Interest Income
(a) Bernardi Honda invested its excess cash from
time to time in short-term instruments which it rolled
over as the investments matured. The Commissioner
determined that some $34,491 in interest was
unreported in 1989.
(b) This amount was duly reported by petitioner
on his Federal income tax return for 1989.
H-3 Depreciation Expense
(a) The Commissioner has recharacterized certain
expenses of Bernardi Honda as capital items as
follows:
1987 1988 1989
---- ---- ----
Leasehold improvements $13,509 $1,175 $5,250
Equipment 9,112 7,420 8,115
Furniture and fixtures 1,391
(b) The Commissioner has calculated depreciation
expense allowable with respect to the capitalized
expenses.
(c) The expenses are ordinary and necessary
business expenses incurred in the course of Bernardi
Honda's trade or business.
(d) In the alternative, the expenditures are
either equipment or furniture and fixtures, and not
leasehold improvements.
(e) In the alternative, the depreciation computed
by the Commissioner omits the depreciation on the
furniture and fixtures of $243 in 1989.
H-4 Cost of Goods Sold
(a) In March 1989, a check for $90,000 was
written to the Commonwealth of Massachusetts for 1988
taxes.
(b) The amount in question was later reclassified
as part of Bernardi Honda's accessories inventory.
(c) The amount in question represents a
reclassification of balance sheet items only and does
not affect the profit or loss of the business.
H-5 Other Expenses
1/3/89 Lincoln National $ 3,236.00 (c)
1/20/89 Davis, Malm & D'Agostine 1,238.70 (c)
1/26/89 Integrated Resources 6,952.99 (c)
2/9/89 Ducas 975.00 (d)
2/14/89 Davis, Malm & D'Agostine 1,000.00 (c)
3/2/89 Am. Garage Door 2,381.00 (a)
3/16/89 Neway Mfg. Inc. 338.00 (b)
3/17/89 Brochu Landscape 80.00 (c)
3/17/89 Jim Fisher, Elect. 290.00 (b)
3/20/89 Davis, Malm & D'Agostine 772.50 (d)
3/20/89 Garino's 558.00 (b)
3/21/89 Charles Caron 10,000.00 (d)
4/6/89 Lincoln National 3,236.00 (d)
2/17/89 Davis, Malm & D'Agostine 500.00 (c)
4/21/89 Bergin & Crotty 930.00 (c)
4/28/89 Jim Fisher Elect. 512.00 (b)
5/15/89 Fitzgerald & Vaugn 4,237.50 (d)
5/17/89 Jager, Smith & Tester 3,060.00 (d)
6/12/89 Robert P. Giargiari 248.91 (d)
6/14/89 Davis, Malm & D'Agostine 854.65 (d)
6/27/89 Lincoln National 3,236.00 (c)
7/6/89 Integrated Resources 6,689.77 (d)
7/7/89 Robert Giargiari 501.14 (d)
7/13/89 Jager, Smith & Tester 1,003.30 (d)
7/13/89 James Brochu 3,905.00 (d)
7/15/89 Robert Giargiari 1,618.59 (d)
7/17/89 Ducas 475.00 (c)
7/24/89 Davis, Malm & D'Agostine 37.65 (d)
7/28/89 Office of Parking 639.00 (c)
8/3/89 Fred Bray 998.00 (a)
8/3/89 Automotive Warehouse 4,070.00 (b)
9/9/89 Ellis Construction 5,000.00 (d)
9/14/89 Bruce Fisher 250.00 (a)
9/6/89 Jim Fisher Elect. 1,621.00 (a)(b)
9/6/89 Thomas Powers 127.77 (d)
9/6/89 Reynolds & Reynolds 2,317.00 (b)
9/21/89 James Brochu 1,780.00 (c)
9/27/89 Davis, Malm & D'Agostine 2,000.00 (d)
10/18/89 Ducas 475.00 (d)
10/25/89 Davis, Malm & D'Agostine 4,066.75 (d)
11/2/89 Conn. Life 750.00 (d)
11/10/89 James Brochu 250.00 (c)
11/29/89 Bob Connor 475.00 (d)
12/11/89 Ellis Construction 5,000.00 (d)
12/20/89 James Brochu 505.00 (d)
12/20/89 Davis, Malm & D'Agostine 2,247.70 (d)
12/21/89 CASH 1,556.00 (g)
12/22/89 Davis, Malm & D'Agostine 90.00 (d)
6/28/89 Ryan Service Center 1,499.96 (d)
6/28/89 Div. of Empl. Sec. 5,744.00 (d)
11/10/89 NO NAME IN BOOKS 529.00 (d)
11/29/89 Integrated Resources 6,567.66 (d)
12/4/89 NO NAME IN BOOKS 310.56 (d)
12/28/89 NO NAME IN BOOKS 329.50 (d)
7/24/89 Liberty Honda 24,614.49 (h)
5/10/89 James Brochu 157.00 (c)
6/7/89 James Brochu 732.50 (c)
10/12/89 James Brochu 288.00 (c)
-----------
TOTAL 1989 ADJUSTMENTS $134,065.00
===========
(a) Capitalized leasehold improvement
(b) Capitalized equipment
(c) Non-deductible, not this taxpayer's expense
(d) Unallowable deduction, substantiation etc.
(e) Capitalized furniture and fixtures
(f) 20% of entertainment adjusted as required
(g) This created a receivable which did not exist and which
was subsequently washed out of the books by a receipt
which was not reported as income as it went against
this receivable. Therefore this is added to income
treated here as though it were an adjustment to an
expense which has the same impact tax wise.
(h) The check issued was in the amount of $16,409.40 and
its was issued to acquire parts at 40 cents on the
dollar from Liberty Honda. Once the parts were acquired
they were returned to Honda by this entity for a total
of $41,023.49 at about the same time. This should have
resulted in the recognition of gain in the amount of
the difference between the purchase price and the
amount received from Honda but that did not happen. It
didn't happen because of a quirk in the computerized
record systems of auto dealerships. The parts inventory
of an auto dealer are not maintained on the cost basis,
instead the parts are always carried at replacement
cost. Because of this the parts inventory when the
parts from the Liberty Honda purchase were entered
carried them at the subsequent sale price, not the
purchase price. The result for the inventory was that
it was understated by the amount of the difference and
since there was no correction at year end (No inventory
was that it was understated by the amount of the
difference and since there was no correction at year
end (No inventory records have been provided even
though they have been requested.) that understatement
remained. The proper accounting, when these facts are
considered together is to recognize the gain at the
point of entry into the system which in this case is
also the point of sale and therefore the income of the
company is increased by the difference between purchase
and sale price.
(b) Each of the foregoing payments were made on
account of ordinary and necessary business expenses
incurred by Bernardi Honda in the ordinary course of
business.
(c) In the alternative, if it is determined that
any of said payments were not properly deductible by
Bernardi Honda because they were made on account of
expenses of other related taxpayers, then a
corresponding deduction should be allowed to the
related taxpayer. As a consequence of said deduction,
the petitioner's share of distributable S corporation
income from such other corporation should be
correspondingly reduced.
(d) In 1989, Bernardi Honda deducted as an "other
expense" $107,592 in cash. The accountant's workpapers
indicate that this entry was made "to write off
remaining savings balance as a distribution to owner."
(c) The amount deducted represents an ordinary
and necessary business expense or loss incurred during
the in the course of Bernardi Honda's business.
H-6 Temp. and Cont. Services Expense
(a) (i) During 1989, Bernardi Honda wrote off
$6,741.33 in securities as temporary and contract
services. The journal entry states that it is made "to
reclassify from securities account."
(ii) The Commissioner determined that there was
no support for this deduction.
(iii) The amount deducted represents an ordinary
and necessary business expense or loss incurred in the
course of Bernardi Honda's business.
(b) (i) During 1989, Bernardi Honda paid Robert
Goodwin a $40,000 consulting fee.
(ii) The Commissioner determined that this
payment was made in consideration of Goodwin's sale of
his stock in Norwell Cars, Inc. to Mr. Carney.
(iii) To the contrary, this payment was made
pursuant to a written Consulting Agreement dated
September 30, 1988 between Goodwin and Bernardi Honda
for which valuable services were provided and
constitutes an ordinary and necessary business expense
of Bernardi Honda.
I. Distributive Share - Crown Chevrolet Trust
Crown Chevrolet Trust ("Crown Chevrolet") is a
Massachusetts business trust taxable as a corporation for
Federal income tax purposes. It operates a Chevrolet and Hyundai
dealership in Framingham, Massachusetts. It is wholly owned by
James Carney and filed an income tax return as an S corporation
on Form 1120S for calendar year 1989.
The proposed adjustments to income are ($317,682) for 1989,
summarized as follows:
1. Amortization expense $ 170,000
2. Other income - inventory valuation (482,682)
----------
$(317,682)
==========
I-1 Amortization Expense
(a) In 1987, James Carney acquired all of the
shares of two Massachusetts corporate trusts, Crown
Chevrolet and Crown Oldsmobile-Toyota Trust ("Crown
Olds-Toyota"). The purchase price for the shares was
$3,012,000, the net book value of the corporations.
(b) At the same time, Crown Chevrolet and Crown
Olds-Toyota entered into agreements with Mr. Glick,
the former owner of the businesses, providing for the
payment of $2,210,000 in consideration of a covenant
not to compete for a period of five years. Crown
Chevrolet amortized its share of the cost of the
covenant ($1,105,000) over five years, claiming a
deduction of $222,224 in 1989.
(c) The Commissioner determined that the value of
the business purchased was $4,700,000 rather than
$3,012,000 and that the portion of the purchase price
allocated to the covenant not to compete was reduced
from $2,210,000 to $522,200.
(d) Accordingly, Crown Chevrolet's amortization
deduction was reduced to $52,224 for 1989.
(e) The price paid by Mr. Carney for the shares
of Crown Chevrolet and the related covenant not to
compete represented the fair market value of those
assets, determined by arms' length negotiations
between unrelated parties.
(f) The cost to Crown Chevrolet of the covenant
not to compete was $1,105,000, which cost may be
amortized over the five year life of the covenant.
I-2 Other Income - Inventory Valuation
(a) In 1989, Crown Chevrolet reduced its LIFO
reserve by $487,682. These adjustments reduced cost of
goods sold and increased income. The Commissioner
disallowed these adjustments in full, resulting in a
$487,682 deduction.
(b) The 1989 Crown Chevrolet LIFO inventory
should be recalculated correctly and the taxable
income in each year adjusted accordingly. Crown
Chevrolet's books and records are available with
respect to its LIFO inventory which can be used as a
basis for recalculation. The petitioner further
asserts that under Rev. Proc. 79-23, 1979-1 C.B. 565,
the following situations do not warrant disallowance
or termination of a LIFO election:
(i) Computational errors made by the
taxpayer in computing the value of its LIFO
inventory and other computational errors made
incident to the LIFO election;
(ii) Selection by the taxpayer of a fewer or
greater number of inventory pools than those
determined by an examining agent; and
(iii) The taxpayer improperly including (or
excluding) a specific item in a particular
inventory pool.
(c) The errors in the computation of the Crown
Chevrolet LIFO reserve are identified in items (i),
(ii) and (iii) above and as such do not justify
termination of the LIFO election.
J. Distributive Share - Crown Oldsmobile - Toyota Trust
Crown Oldsmobile-Toyota Trust ("Crown Olds-Toyota") is a
Massachusetts business trust taxable as a corporation for
Federal income tax purposes. It operates an Oldsmobile and
Toyota dealership in Framingham, Massachusetts. It is wholly
owned by James Carney and filed an income tax return as a S
corporation on Form 1120S for calendar year 1989.
The proposed adjustments to income are ($229,292) for 1989,
summarized as follows:
1. Amortization expense $170,000
2. Other expenses 27,179
3. Depreciation expense 3,854
4. Cost of goods sold - inventory valuation (430,325)
--------
($229,292)
========
J-1 Amortization Expense
(a) In 1987, James Carney acquired all of the
shares of two Massachusetts corporate trusts, Crown
Chevrolet and Crown Olds-Toyota. The purchase price
for the shares was $3,012,000, the net book value of
the corporations.
(b) At the same time, Crown Chevrolet and Crown
Olds-Toyota entered into agreements with Mr. Glick,
the former owner of the businesses, providing for the
payment of $2,210,000 in consideration of a covenant
not to compete for a period of ten years. Crown
Olds-Toyota amortized its share of the cost of the
covenant ($1,105,000) over five years, claiming
$222,224 in 1989.
(c) The Commissioner determined that the value of
the business purchased was $4,700,000 rather than
$3,012,000 and that the portion of the purchase price
allocated to the covenant not to compete should be
reduced from $2,210,000 to $522,200.
(d) Accordingly, Crown Olds-Toyota's amortization
deduction was reduced to $52,224 for 1989.
(e) The price paid by Mr. Carney for the shares
of Crown Olds-Toyota and the related covenant not to
compete represented the fair market value of those
assets, determined by arms' length negotiations
between unrelated parties.
(f) The cost to Crown Olds-Toyota of the covenant
not to compete was $1,105,000, which cost may be
amortized over the five year life of the covenant.
J-2 Other Expenses
(a) The Commissioner determined that numerous
Crown Olds-Toyota expenditures should be disallowed as
ordinary and necessary business expenses for the
reasons set forth below.
1/6/89 Warner & Stackpole $ 2,825.00 (c)
1/16/89 J.J. Bufaro, Inc. 5,912.00 (a)
1/26/89 Am. Express 737.00 (f)
2/28/89 Am. Express 698.00 (f)
3/7/89 The Cost Club 1,320.00 (d)
3/17/89 J.J. Bufaro, Inc. 5,912.00 (a)
4/10/89 Am. Express 1,592.00 (f)
5/14/89 Am. Express 310.00 (f)
6/1/89 Am. Express 361.00 (f)
6/5/89 Lincoln National 900.00 (c)
7/7/89 Am. Express 446.00 (f)
7/19/89 Office of Parking Clerk 256.00 (d)
7/25/89 Am. Express 90.00 (f)
8/7/89 IRS 821.00 (d)
8/29/89 Am. Express 851.00 (f)
9/27/89 Am. Express 380.00 (f)
10/25/89 Am. Express 296.00 (f)
10/25/89 Garage Maint. 2,200.00 (b)
11/29/89 Am. Express 1,243.00 (f)
12/29/89 Am. Express 39.00 (f)
----------
1989 TOTAL EXPENSES DISALLOWED $27,179.00
==========
(a) Capitalized leasehold improvement
(b) Capitalized equipment
(c) Non-deductible, not this taxpayer's expense
(d) Unallowable deduction, substantiation, etc.
(e) Capitalized furniture and fixtures
(f) Unsupported entertainment expenses
(b) Each of the foregoing payments were made on
account of ordinary and necessary business expenses
incurred by Crown Olds-Toyota in the ordinary course
of business.
(c) In the alternative, if it is determined that
any of said payments were not properly deductible by
Crown Olds-Toyota because they were made on account of
expenses of other related taxpayers, then a
corresponding deduction should be allowed to the
related taxpayer. As a consequence of said deduction,
the petitioner's share of distributable corporation S
income from such other corporation should be
correspondingly reduced.
J-3 Depreciation Expense
(a) The Commissioner has recharacterized certain
expenses as capital items as follows:
1987 1988 1989
---- ---- ----
Leasehold improvements $55,738 $ 620 $11,824
Equipment 3,960 2,675
Furniture and Fixtures 804 2,973
(b) The Commissioner has calculated depreciation
expense allowable with respect to the capitalized
expenses. The Commissioner's depreciation adjustments
should reduce rather than increase Crown Olds-Toyota's
ordinary income.
(c) The expenses are ordinary and necessary
business expenses incurred in the course of Crown
Olds-Toyota's trade or business.
(d) In the alternative, the expenditures are
either equipment or furniture and fixtures, with
applicable recovery periods of 5 years and 7 years,
respectively.
J-4 Cost of Goods Sold - Inventory Valuation
(a) In 1989, Crown Olds-Toyota increased its LIFO
reserve by $430,325, all of which was disallowed by
the Commissioner.
(b) The 1989 Crown Olds-Toyota LIFO inventory
should be recalculated correctly and the taxable
income in each year adjusted accordingly. Crown
Olds-Toyota's books and records are available with
respect to its LIFO inventory which can be used as a
basis for recalculation. The petitioner further
asserts that under Rev. Proc. 79-23, 1979-1 C.B. 565,
the following situations do not warrant disallowance
or termination of a LIFO election:
(i) Computational errors made by the
taxpayer in computing the value of its LIFO
inventory and other computational errors made
incident to the LIFO election;
(ii) Selection by the taxpayer of a fewer or
greater number of inventory pools than those
determined by an examining agent; and
(iii) The taxpayer improperly including (or
excluding) a specific item in a particular
inventory pool.
(c) The errors in the computation of the Crown
Olds-Toyota LIFO reserve are identified in items (i),
(ii) and (iii) above and as such do not justify
termination of the LIFO election.
K. Distributive Share - Norwell Cars, Inc.
(a) Norwell Cars, Inc. ("Norwell") is a Massachusetts
corporation wholly owned by James Carney. It operates an
Acura dealership in Norwell, Massachusetts. It filed income
tax returns on Form 1120S for the calendar year 1989.
(b) The proposed adjustments to income for 1989 are
$89,860, as summarized below:
1. Rent expense $62,500
2. Other expenses 6,497
3. Depreciation 20,863
-------
$89,860
=======
K-1 Rent Expenses
(a) During 1989, Norwell accrued $212,500 in rent
payable to James Carney. Mr. Carney only reported
$150,000 of rent from Norwell on his income tax return
for 1989.
(b) The Commissioner determined that Norwell was
not entitled to accrue rent payable to a related
person under Section 267(a)(2) of the Code.
(c) Petitioner concedes that the rent in question
was not deductible in 1989 to the extent it was unpaid
in that year.
K-2 Other Expenses
(a) The Commissioner determined that certain
expenditures by Norwell for calendar year 1989 should
be disallowed as ordinary and necessary business
expenditures, as set forth below:
1/10/89 Davis, Malm & D'Agostine $ 109.53 (e)
1/31/89 Petty Cash (bonuses) 605.00 (e)
3/9/89 W.B. Mason 1,115.10 (e)
4/26/89 Davis, Malm & D'Agostine 168.00 (d)
8/3/89 J. Carney Auto Mall 1,000.00 (a)
8/18/89 Lease Star 3,500.00 (e)
---------
1989 TOTAL $6,457.73
=========
(b) Each of the foregoing payments were made on
account of ordinary and necessary business expenses
incurred by Norwell in the ordinary course of
business.
(c) In the alternative, if it is determined that
any of said payments were not properly deductible by
Norwell because they were made on account of expenses
of other related taxpayers, then a corresponding
deduction should be allowed to the related taxpayer.
As a consequence of said deduction, the petitioner's
share of distributable Subchapter S income from such
other corporation should be correspondingly reduced.
K-3 Depreciation
(a) The Commissioner disallowed $20,863 of
depreciation expense claimed by Norwell in 1989.
(i) The depreciation expense claimed on
Norwell's 1989 tax return, as filed, is correct.
(ii) In the alternative, additional
depreciation is allowable on expenditures
capitalized by the Commissioner.
(b) Depreciation on expenditures capitalized by
the Commissioner.
(i) The Commissioner recharacterized certain
expenses of Norwell as capital items as follows:
1988 1989
---- ----
Leasehold Improvements $12,026
Equipment 20,437 4,500
Furniture and Fixtures 21,424 1,115
(ii) The Commissioner calculated
depreciation expense allowable with respect to
the capitalized expenses.
(iii) The expenses are ordinary and
necessary business expenses incurred in the
course of Norwell's trade or business.
(iv) In the alternative, the capitalized
expenditures are properly classified as having
recovery periods of 5 or 7 years.
(c) Additional Boston Car Company expenditures.
(i) The Commissioner has disallowed $128,344
of expenditures made by Boston Car Company in
1987.
(ii) The $128,344 of Boston Car Company
expenditures are ordinary and necessary expenses
incurred in the course of Boston Car Company's
trade or business.
(iii) In the alternative, the $128,344 of
Boston Car Company expenditures represent funds
advanced on behalf of Norwell to acquire capital
assets that are subject to an allowance for
depreciation under Section 167 of the Code.
WHEREFORE, petitioner prays that this Court determine that no deficiencies in income tax exist for the calendar year 1989.
William F. Griffin, Jr.
Attorney for Petitioner
Davis, Malm & D'Agostine, P.C.
One Boston Place
Boston, Massachusetts 02108
(617) 367-2500
T.C. Bar No. GW0286
Dated: June 3, 1993
- CourtUnited States Tax Court
- DocketDocket No. 11248-93
- AuthorsGriffin, William F., Jr.
- Code Sections
- Jurisdictions
- LanguageEnglish
- Tax Analysts Document NumberDoc 93-75171
- Tax Analysts Electronic Citation93 TNT 148-66
