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The parties do not address the application of section
7491(a) or (c) in the instant case. Respondent issued the notice
of deficiency on August 28, 2003, and it is possible that
respondent's examination of petitioners’ returns for 1996, 1997,
1998, and 1999 began after July 22, 1998. However, petitioners
do not argue that the burden of proof shifts to respondent under
section 7491(a) and have not shown that the threshold
requirements of section 7491(a) were met. We decide the issues
involving petitioners’ unreported income on a preponderance of
the evidence, and the burden of proof does not affect the
outcome.
We shall first address petitioners’ contention that they
were not required to report as gross income the amounts IMC
reimbursed petitioner for his expenses, which included travel and
the purchases of new equipment on behalf of IMC. We shall then
address petitioner’s contention that the remainder of the
payments made by IMC were returns of petitioner’s capital with
respect to the sale of his old tools to IMC.
I. Accountable Plan
Section 61 includes in gross income all income, from
whatever source derived. Section 62 defines adjusted gross
income as gross income minus certain deductions. Section
62(a)(2)(A) allows taxpayers to deduct from gross income amounts
paid by the taxpayer “in connection with the performance by him
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