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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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