- -13
predecessor of * * * [section 61] provided that: "In
the case of a manufacturing, merchandising, or mining
business, 'gross income' means the total sales, less
cost of goods sold, plus any income from investments
and from incidental income or outside operations."
* * * Currently, I.R.C. section 61(a)(2) includes
gross income from business as part of gross income, and
the regulations thereunder still contain the language
quoted above from the 1939 version of the I.R.C. See
Treas. Reg. sec. 1.61-3 (1994). Because the [cost of
goods sold] is subtracted from total sales in arriving
at gross income, it follows that a taxpayer's
overstatement of the [cost of goods sold] on his
income-tax return is an item omitted from gross income.
[Lilly v. Internal Revenue Service; supra at 572;
emphasis added.]
We regard this statement by the Fourth Circuit as consistent
with our conclusion that if items shown as cost of goods sold on
a taxpayer's return are disallowed, absent an explanation in the
notice of deficiency to the contrary, the disallowance results in
an omission from gross income. We conclude that this case is not
distinguishable from prior cases involving a disallowance of
claimed cost of goods sold subtracted from gross receipts to
arrive at gross income.
Petitioner contends that she is also entitled to relief
under section 6013(e) with respect to the Schedule C deductions
disallowed by respondent. We disagree with petitioner. A
deduction having no basis in fact or in law is a deduction that
is frivolous, fraudulent, or phony. Douglas v. Commissioner, 86
T.C. 758, 763 (1986). It is clear that Mr. Velinsky was in the
business of band management and had business deductions during
the year in issue, but, as in Douglas v. Commissioner, supra, the
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