Steven M. and Karen Arhontes - Page 5




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               In the notice of deficiency, respondent disallowed all of              
          the claimed cost of goods sold and all of the claimed car and               
          truck expenses and depreciation deductions for lack of                      
          substantiation.2  As a result of these adjustments, respondent              
          made computational adjustments to petitioners' itemized                     
          deductions, self-employment taxes, and self-employment tax                  
          deduction for 1997.  Respondent also determined that petitioners            
          were liable for the accuracy-related penalty under section                  
          6662(a) for negligence or disregard of rules and regulations in             
          the amount of $2,194.60.                                                    
               The first issue is whether petitioners are entitled to                 
          reduce gross receipts by a cost of goods sold of $38,897 in                 
          connection with Spanky's.  In order to compute the gross income             
          of a Schedule C business, gross receipts are reduced by cost of             
          goods sold.3  Sec. 1.61-3(a), Income Tax Regs.  Cost of goods               
          sold is computed by subtracting the value of ending inventory               
          (goods still on hand at the end of the year) from the sum of the            
          opening inventory and purchases during the year.  Primo Pants Co.           
          v. Commissioner, 78 T.C. 705, 723 (1982).  Any amount claimed as            



               2    Respondent made no adjustment to the $9,875 in gross              
          receipts reported by petitioner.                                            
               3    Such costs are not treated as deductions and are not              
          subject to the limitations on deductions contained in secs. 162             
          and 274.  Metra Chem Corp. v. Commissioner, 88 T.C. 654, 661                
          (1987).  See infra discussion on pages 8 and 9.                             





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