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Deductions. For 1993, petitioners reported on Schedule C a loss of
$48,483 from the operation of Stanton Mexicatessen, and interest
expenses of $10,277 on Schedule A. For 1994, petitioners did not
file a Schedule C and did not report any income or loss from the
operation of Stanton Mexicatessen.
Petitioners filed Form 4797, Sales of Business Property, for
1994 and reported a loss from the sale of Stanton Mexicatessen's
assets of $123,557 (less a $4,712 gain from the disposition of
other restaurant property for a net loss of $118,845). Form 4797
reported a sales date for the restaurant of January 1, 1994.
Notice of Deficiency
Respondent asserts that petitioners gave Ms. Eagatatt a
security interest in the assets of Stanton Mexicatessen, as opposed
to selling the restaurant to her. Accordingly, respondent
determined that because petitioners did not sell Stanton
Mexicatessen, they are not entitled to the claimed capital loss for
1994. As a consequence of that determination, respondent
determined that petitioners failed to report the restaurant income
for 1994, and further, that they underreported the restaurant
income for 1992 and 1993. Respondent, therefore, reconstructed
petitioners' restaurant income for each of the years in issue by
determining the net profit from the restaurant as 3 percent of the
restaurant's gross receipts (as reported by petitioners in 1992 and
1993, and as reported by Ms. Eagatatt in 1994).
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