Midwest Industrial Supply, Inc. - Page 4

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               In 1985, petitioner advertised through trade publications and product  
          brochures and claimed an advertising deduction of approximately $11,000.  In
          1986, while continuing to advertise through trade publications and product  
          brochures, petitioner also began to sponsor Sussex Farm.  Prior to doing so,
          petitioner consulted with John Alan Cohan, an attorney specializing in      
          equestrian matters, and was informed that petitioner's sponsorship of Sussex
          Farm might be deductible as an ordinary and necessary business expense.  The
          terms of petitioner's sponsorship of Sussex Farm were not formalized in a   
          written contract.  Instead, Mr. Vitale, in his capacity as petitioner's sole
          director, determined how much to pay Sussex Farm.  On its 1986, 1987, 1988, 
          and 1989 tax returns, petitioner deducted advertising expenses in the amounts
          of $66,145, $66,323, $42,295, and $30,314, respectively.  Of those amounts, 
          the total advertising expenses attributable to payments to or on behalf of  
          Sussex Farm in 1986, 1987, 1988, and 1989 were $55,850, $51,500, $35,206, and
          $20,650, respectively.  In each of these years, the amount paid was equal to
          Sussex Farm's net expenses.                                                 
               During the years in issue, Sussex Farm owned between 15 and 19 horses. 
          Sussex Farm showed one horse in 1986 and two horses in 1987, 1988, and 1989 in
          various equestrian competitions.  Whenever one of Sussex Farm's horses was  
          shown, petitioner's name was announced over a loudspeaker as the sponsor of 
          the horse.                                                                  
               On audit respondent challenged petitioner's advertising deductions     
          relating to Sussex Farm, and petitioner in response discontinued its        
          sponsorship of Sussex Farm in 1990.                                         
          I.  Deductibility of Petitioner's Payments to Sussex Farm                   
               A.  In General                                                         
               The initial question before us is whether the payments in issue        
          constituted deductible business expenses, as petitioner maintains, or       

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