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during the taxable year 1994 in the amount of $489 ($4,578 less
$4,089).
2. Cost of Goods Sold
Respondent disallowed the cost of goods sold which
petitioner claimed on Schedules C of her returns for the taxable
years 19946 and 1995.
In disallowing the cost of goods sold claimed by petitioner
for 1995, respondent did not contest petitioner's
characterization of the items in question as costs of goods sold
rather than as claims for deductible expenses under section 162.
The cost of goods sold is subtracted from gross receipts for
purposes of determining gross income, whereas business expenses
are deducted from gross income. Hahn v. Commissioner, 30 T.C.
195, 197 (1958), affd. per curiam 271 F.2d 739 (5th Cir. 1959).
In effect, cost of goods sold, unlike business expenses, is
excluded from gross income. Section 1.61-3(a), Income Tax Regs.,
provides that "In a manufacturing, merchandising, or mining
business, 'gross income' means the total sales, less the cost of
goods sold".
6 We do not consider respondent's adjustment to cost of
goods sold for 1994. Any allowance by the Court would result in
an increase in petitioner's expenditures, which would have the
effect of increasing income under the source and application of
funds analysis. Since we have fully addressed respondent's
reconstruction of petitioner's income for 1994, we see no reason
to address separately respondent's adjustment with respect to
costs of goods sold for 1994.
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