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proceeds of the Farmers lawsuit allocated to, and received by,
the Diamonds as the owners of ETS from $400,000 to $450,245.
Tax Return Treatment
In the return that it filed for its taxable year ended
September 30, 1988, and that Mr. Donnelly signed as return
preparer, DCI included in gross income the entire amount of the
proceeds of the Farmers lawsuit (viz., $2,254,983). DCI claimed
a $450,245 deduction for "CONTRACT SERVICES". DCI also claimed
various other deductions, including deductions for legal and
accounting fees in the amounts of $715,814 and $9,708, respec-
tively.
The Diamonds filed a joint return for 1988 that Mr. Donnelly
signed as return preparer. In Schedule C of that return, the
Diamonds reported $450,245 of gross receipts, $9,600 of other
income, $1,696 of expenses that included $880 of legal and
accounting fees, and $458,149 of net profits from the operations
of ETS.
Notice of Deficiency
In the notice of deficiency (notice), respondent determined,
inter alia, that DCI's taxable income for the taxable year ended
September 30, 1988, must be increased by $411,086. The notice
stated in pertinent part:
It is determined that for the taxable year ended 9-30-
88 your gross income is understated in the amount of
$411,086.00 which represents a portion of the lawsuit
income received from Farmers Insurance Company and
improperly allocated to your sole shareholder. This
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