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III. The C. Shirleys
A. Deficiency in Tax
1. Introduction
C E Shirley Trust reported as income the income distribution
of $63,481 received from Caralan Trust. It deducted $286 on
account of a distribution of income to Congo Trust. It computed
a depreciation deduction of $647 and apportioned that deduction
in full to Congo Trust. Congo Trust took into account both of
those items. It also reported rental receipts of $12,000 on
account of a rental activity involving the C. Shirleys’ principal
residence. It claimed related deductions (not including
depreciation) of $23,101, giving rise to a loss of $11,101.
Congo Trust computed a depreciation deduction of $8,558, which it
apportioned to the C. Shirleys. The only trust-related item on
the C. Shirleys’ 1995 return is a deduction of $10,463 on account
of unreimbursed expenses related to Congo Trust.
Respondent determined a deficiency in the C. Shirleys’ tax
by notice dated August 5, 1999 (the C. Shirleys’ notice). One
adjustment giving rise to that determination is a positive
adjustment to the C. Shirleys’ gross income of $12,000, which
increase is attributable to $12,000 of rental income reported on
the Congo Trust 1995 return. Respondent concedes that
adjustment. A second adjustment is a negative adjustment of
$10,463, reflecting the C. Shirleys’ deduction of $10,463 on
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