Essel Eyewear, Inc.

• Court: United States Tax Court
• Decided: January 31, 2024
• Docket: 10823-22
• Status: Unpublished

Opinion

United States Tax Court

T.C. Memo. 2024-11

ESSEL EYEWEAR, INC., Petitioner

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

__________

Docket No. 10823-22. Filed January 31, 2024.

Joseph Y. Balisok, for petitioner.

Massimiliano Valerio and James P.A. Caligure, for respondent.

MEMORANDUM OPINION

LAUBER, Judge: With respect to petitioner’s Federal income tax for 2018 and 2019, the Internal Revenue Service (IRS or respondent) determined deficiencies of $46,846 and $23,794, respectively, and pen- alties of $9,369 and $4,759. The deficiencies stem from unreported gross receipts and the disallowance of claimed deductions. Respondent has filed a Motion for Summary Judgment under Rule 121, 1 contending that there are no genuine disputes of material fact and that he is entitled to judgment as a matter of law. We agree and accordingly will grant the Motion.

1 Unless otherwise indicated, statutory references are to the Internal Revenue

Code, Title 26 U.S.C. (Code), in effect at all relevant times, regulation references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times, and Rule references are to the Tax Court Rules of Practice and Procedure. We round all monetary amounts to the nearest dollar.

Served 01/31/24 2

[*2] Background

The following facts are based on the parties’ pleadings and re- spondent’s Motion papers, including the Declarations and Exhibits at- tached thereto. See Rule 121(c). We also rely on facts deemed admitted by virtue of petitioner’s failure to respond to requests for admissions. See Rule 90(f). Petitioner had its principal place of business in Brooklyn, New York, when its Petition was timely filed.

During 2018 and 2019 petitioner engaged in the business of sell- ing eyewear at wholesale. It filed timely returns for both years on Form 1120, U.S. Corporation Income Tax Return. The IRS selected these re- turns for examination and assigned the audit to Revenue Agent (RA) Karen Chen.

To verify the gross receipts reported on these returns, RA Chen summonsed the bank records of petitioner and its sole shareholder. For 2018 she determined that an $11,000 business receipt belonging to peti- tioner had been deposited into the shareholder’s account and was ex- cluded improperly from petitioner’s gross receipts. For 2019 she deter- mined that petitioner’s bank account had unexplained deposits of $25,894 that should have been included in its gross receipts. She pro- vided her bank deposits analysis to petitioner and its representative. Neither presented any evidence that the $36,894 (or any portion thereof) derived from nontaxable sources or was otherwise excludable from peti- tioner’s gross income.

To verify petitioner’s reported cost of goods sold (COGS) and busi- ness expense deductions, RA Chen requested substantiation from peti- tioner. Its representative supplied documents in several phases during 2021, and RA Chen revised her findings accordingly. She determined that petitioner had substantiated only a portion of its reported COGS, advertising expenses, and “other” deductions for 2018 and 2019 and that it had substantiated none of a $2,000 bad debt deduction claimed for 2019. On the other hand, she concluded that petitioner should be al- lowed an additional deduction of $6,500 for each year for rental ex- penses.

On October 1, 2021, RA Chen prepared and forwarded to her man- ager for approval a draft 30-day letter setting forth her proposed adjust- ments. She included in this package a civil penalty approval form rec- ommending that a 20% accuracy-related penalty be asserted for each year. Acting Group Manager (AGM) Nadezhda Khasin returned the 3

[*3] package that same day, approving the assertion of 20% penalties for substantial understatements of income tax (or alternatively for neg- ligence). See § 6662(a) and (b)(1) and (2). The form bears AGM Khasin’s digital signature dated October 1, 2021.

RA Chen forwarded her draft report to petitioner and revised it after receiving additional information. On November 30, 2021, she fi- nalized her examination report. After adjusting petitioner’s gross re- ceipts, COGS, and allowable deductions in accordance with her findings, she determined that petitioner’s 2018 taxable income should be in- creased from $30,268 to $253,342, and that its 2019 taxable income should be increased from $20,293 to $133,600. These adjustments gen- erated income tax deficiencies of $46,846 and $23,794:

2018 Return Item As Reported Adjustment As Redetermined

Gross Receipts $701,724 $11,000 $712,724

Returns/Allowances (6,983) -0- (6,983)

COGS (419,427) 150,421 (269,006)

Gross Profit $275,314 $161,421 $436,735

Salaries (15,000) -0- (15,000)

Repairs (13,986) -0- (13,986)

Taxes (1,219) -0- (1,219)

Charitable Contributions (3,363) -0- (3,363)

Rents (12,000) (6,500) (18,500)

Advertising (44,042) 24,959 (19,083)

Other Deductions (155,436) 43,194 (112,242)

Total Deductions ($245,046) $61,653 ($183,393)

Taxable Income $30,268 $223,074 $253,342

Tax Liability $6,356 $46,846 $53,202 4

[*4] 2019 Return Item As Reported Adjustment As Redetermined

Gross Receipts $770,798 $25,894 $796,692

Returns/Allowances (5,723) -0- (5,723)

COGS (391,128) 39,802 (351,326)

Gross Profit $373,947 $65,696 $439,643

Salaries (19,500) -0- (19,500)

Repairs (86,024) -0- (86,024)

Bad debts (2,000) 2,000 0

Taxes (1,492) -0- (1,492)

Charitable Contributions (1,981) -0- (1,981)

Advertising (44,047) 25,047 (19,000)

Other Deductions (186,610) 27,063 (159,547)

Total Deductions ($353,654) $47,610 ($306,044)

Taxable Income $20,293 $113,307 $133,600

Tax Liability $4,262 $23,794 $28,056

RA Chen sent her final report to petitioner and its representative but received no further response. On January 5, 2022, her manager closed the examination. On April 5, 2022, the IRS issued petitioner a notice of deficiency determining the tax deficiencies and penalties set forth supra page 1.

On May 9, 2022, petitioner timely petitioned this Court, assigning error to every determination in the notice of deficiency. Shortly after respondent filed his Answer, the case was referred to the IRS Independ- ent Office of Appeals (Appeals) to consider whether the case could be 5

[*5] resolved without trial. In August 2022 the case was assigned to an Appeals officer (AO), who requested substantiation supporting peti- tioner’s return position and the assignments of error in the Petition. Pe- titioner had supplied no relevant information to the AO as of January 2023, when this case was placed on a May trial calendar.

On February 13, 2023, respondent served on petitioner a First Request for Admissions. In 11 numbered paragraphs, respondent asked petitioner to admit that it had “no documents” showing that the IRS erred in adjusting its gross receipts, COGS, advertising expenses, bad debt deduction, and “other” deductions as set forth in the notice of defi- ciency. Respondent advised petitioner that “pursuant to Tax Court Rules 90(c) and 90(f), each matter in the foregoing requests will be deemed admitted, and conclusively established for purposes of this case, unless you serve a written answer or an objection to these requests within 30 days after the date these requests for admissions were served on you.” Petitioner filed no response to the First Request for Admissions by the March 15 deadline or subsequently. The matters covered by that request are thus deemed admitted. See Rule 90(c).

On March 8, 2023, the case was continued from the May trial cal- endar upon a representation from petitioner’s counsel that “[p]etitioner is actively working with IRS Office of Appeals . . . to settle the outstand- ing issues raised in the Petition.” On June 8, 2023, the AO informed respondent’s counsel that petitioner had supplied no substantiation or documentation of any kind during the Appeals process. Petitioner was sent a “last chance” letter, but it supplied nothing in response to that letter.

On July 6, 2023, the AO returned the case to respondent’s counsel for trial preparation. On July 20, 2023, respondent served on peti- tioner’s counsel a Second Request for Admissions. Respondent asked petitioner to admit that a civil penalty approval form, attached as Ex- hibit A to the Request, was a “true and genuine copy” of the civil penalty approval form signed by AGM Khasin on October 1, 2021. Respondent also requested that petitioner admit that AGM Khasin’s approval was timely secured, that petitioner for 2018 and 2019 “is liable for the sub- stantial understatement penalty . . . in the amounts determined in the statutory notice of deficiency,” and that “[t]he adjustments and compu- tations in the statutory notice of deficiency . . . are correct in all re- spects.” 6

[*6] The Second Request for Admissions (like the First) advised peti- tioner that “pursuant to Tax Court Rules 90(c) and 90(f), each matter in the foregoing requests will be deemed admitted, and conclusively estab- lished for purposes of this case, unless you serve a written answer or an objection to these requests within 30 days after the date these requests for admissions were served on you.” Petitioner did not respond to the Second Request for Admissions by the August 19 deadline or subse- quently. The matters covered therein are thus deemed admitted. See Rule 90(c).

On September 1, 2023, the Court placed this case on a January 22, 2024, New York, New York, trial calendar. On September 28, 2023, respondent filed a Motion for Summary Judgment, urging that the defi- ciencies and penalties set forth in the notice of deficiency should be sus- tained in full. We directed petitioner to respond to the Motion by Octo- ber 30, 2023, warning that “under Tax Court Rule121(d), judgment may be entered against a party who fails to respond to a Motion for Summary Judgment.” Petitioner did not respond to the Motion by that date or subsequently.

Discussion

I. Summary Judgment

The purpose of summary judgment is to expedite litigation and avoid costly, time-consuming, and unnecessary trials. Fla. Peach Corp. v. Commissioner, 90 T.C. 678, 681 (1988). The Court may grant sum- mary judgment when there is no genuine dispute as to any material fact and a decision may be rendered as a matter of law. Rule 121(a)(2); Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff’d, 17 F.3d 965 (7th Cir. 1994). In deciding whether to grant summary judg- ment, we construe factual materials and inferences drawn from them in the light most favorable to the nonmoving party. Sundstrand Corp., 98 T.C. at 520.

Facts deemed admitted under Rule 90(c) are considered conclu- sively established and may be relied upon in deciding whether to grant a motion for summary judgment. See Marshall v. Commissioner, 85 T.C. 267, 272–73 (1985); Morrison v. Commissioner, 81 T.C. 644, 651–52 (1983); Doncaster v. Commissioner, 77 T.C. 334, 336 (1981). Where the moving party makes and properly supports a motion for summary judg- ment, “the nonmovant may not rest on the allegations or denials in that party’s pleading” but must set forth specific facts, by affidavit or 7

[*7] otherwise, showing that there is a genuine dispute for trial. Rule 121(d); see Sundstrand Corp., 98 T.C. at 520.

Because petitioner did not respond to the Motion for Summary Judgment, we could enter a decision against it for that reason alone. See Rule 121(d). We will nevertheless consider the Motion on its merits. Given the facts deemed admitted, we conclude that no material facts are in genuine dispute and that this case is appropriate for summary adju- dication.

II. Burden of Proof

The Commissioner’s determinations in a notice of deficiency are generally presumed correct, and the taxpayer bears the burden of prov- ing them erroneous. Rule 142(a); see Welch v. Helvering, 290 U.S. 111, 115 (1933). In certain circumstances section 7491 may shift to the Com- missioner the burden of proof on factual issues. But that section applies only if the taxpayer (among other things) “introduces credible evidence” and “has maintained all records required under this title.” See § 7491(a)(1), (2)(B). Petitioner does not contend, and it could not plau- sibly contend, that it met these requirements.

III. Gross Income

“[G]ross income means all income from whatever source derived,” including income derived from business. § 61(a); Commissioner v. Glen- shaw Glass Co., 348 U.S. 426, 429–31 (1955). In cases of unreported income, the Commissioner must establish an evidentiary foundation connecting the taxpayer with the income-producing activity, see Llorente v. Commissioner, 649 F.2d 152, 156 (2d Cir. 1981), aff’g in part, rev’g and remanding in part 74 T.C. 260 (1980), or demonstrate that the tax- payer actually received income, Edwards v. Commissioner, 680 F.2d 1268, 1270–71 (9th Cir. 1982). “Once the Commissioner makes the re- quired threshold showing, the burden shifts to the taxpayer to prove by a preponderance of the evidence that the Commissioner’s determina- tions are arbitrary or erroneous.” Walquist v. Commissioner, 152 T.C. 61, 67–68 (2019) (citing Helvering v. Taylor, 293 U.S. 507, 515 (1935)); see Texasgulf, Inc., & Subs. v. Commissioner, 172 F.3d 209, 214 (2d Cir. 1999), aff’g 107 T.C. 51 (1996).

The Commissioner reconstructed petitioner’s income using the bank deposits method. Taxpayers must maintain books and records suf- ficient to establish their income and expenses. §§ 6001, 446(b); Petzoldt v. Commissioner, 92 T.C. 661, 693 (1989); Treas. Reg. § 1.6001-1(a). 8

[*8] When a taxpayer fails to do so, the Commissioner may reconstruct its income by examining its bank deposits. See Estate of Hague v. Com- missioner, 132 F.2d 775 (2d Cir. 1943), aff’g 45 B.T.A. 104 (1941); DiLeo v. Commissioner, 96 T.C. 858, 881 (1991), aff’d, 959 F.2d 16 (2d Cir. 1992). Bank deposits are prima facie evidence of income, and the Com- missioner need not show a likely source of the revenue. Tokarski v. Commissioner, 87 T.C. 74, 77 (1986). We presume that all money depos- ited into a taxpayer’s account is taxable unless the taxpayer shows that particular deposits are nontaxable or were previously reported as in- come. DiLeo, 96 T.C. at 868; Brodsky v. Commissioner, T.C. Memo. 2001-240, 82 T.C.M. (CCH) 505, 530.

RA Chen summonsed the bank records of petitioner and its sole shareholder. Analyzing the data in those accounts, she prepared and supplied to petitioner a bank deposits analysis—complete with her sup- porting worksheets—showing that petitioner had additional gross re- ceipts of $11,000 for 2018 and $25,894 for 2019. Petitioner provided no evidence that these deposits reflected nontaxable items or that her anal- ysis was incorrect in any respect. We accordingly find that respondent’s implementation of the bank deposits method was reasonable and pro- vided a sufficient evidentiary foundation connecting petitioner with the unreported income. See Petzoldt, 92 T.C. at 687 (noting that the IRS’s reconstruction of a taxpayer’s income “need only be reasonable in light of all surrounding facts and circumstances”).

In any event, petitioner failed to respond to both Requests for Ad- missions. Petitioner is thus deemed to have admitted that the adjust- ments in the notice of deficiency “are correct in all respects” and that “it does not have any documents showing that respondent erred” in calcu- lating its gross income. See Rule 90(c). These deemed admissions alone suffice to establish that no genuine dispute exists as to the issue of un- reported income. See Marshall, 85 T.C. at 272–73. We accordingly con- clude that respondent’s determinations of unreported gross receipts for 2018 and 2019, as set forth in the notice of deficiency, are correct, and those determinations are sustained. See Hardy v. Commissioner, 181 F.3d 1002, 1004–05 (9th Cir. 1999), aff’g T.C. Memo. 1997-97; Pow- erstein v. Commissioner, T.C. Memo. 2011-271, 102 T.C.M. (CCH) 497, 506.

IV. Cost of Goods Sold and Deductions

Deductions are a matter of legislative grace, and taxpayers gen- erally bear the burden of proving that claimed business expenses were 9

[*9] actually incurred and were “ordinary and necessary.” § 162(a); Rule 142(a); see INDOPCO Inc. v. Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). Taxpayers also bear the burden of substantiating the amounts of their deductions by keeping and producing records sufficient to enable the IRS to deter- mine the correct tax liability. See § 6001; Treas. Reg. § 1.6001-1(a).

“Costs of goods sold” is an offset subtracted from gross receipts in determining gross income. Treas. Reg. § 1.61-3(a). Technically speak- ing, COGS is not a “deduction.” See Metra Chem Corp. v. Commissioner, 88 T.C. 654, 661 (1987). However, any amount claimed as COGS also must be substantiated, and taxpayers are required to maintain records sufficient for this purpose. § 6001; Nunn v. Commissioner, T.C. Memo. 2002-250, 84 T.C.M. (CCH) 403, 408; Treas. Reg. § 1.6001-1(a).

RA Chen concluded, on the basis of documents supplied during the examination, that petitioner had failed to substantiate a portion of its reported COGs, advertising expenses, and other deductions for 2018 and 2019 and had substantiated none of the bad debt deduction reported for 2019. After receiving RA Chen’s final examination report, petitioner provided no evidence to her, to the AO, or to respondent’s counsel to sub- stantiate the amounts disallowed. Because petitioner failed to meet its burden of substantiation, we can sustain respondent’s disallowance of its claimed deductions and expenses on this ground alone. 2

In any event, petitioner failed to respond to respondent’s Re- quests for Admissions and is thus deemed to have admitted that the ad- justments in the notice of deficiency are “correct in all respects” and that no documents exist showing that respondent erred in disallowing the amounts of these items. See Rule 90(c). Petitioner’s deemed admissions suffice to establish that no genuine dispute exists regarding the disal- lowed COGS and deductions for 2018 and 2019 and the disallowed bad debt expense for 2019. See Marshall, 85 T.C. at 272–73. We accordingly conclude that respondent’s determinations on these points, as set forth

2 If a taxpayer establishes that deductible expenses were incurred but fails to

establish the precise amounts, we may estimate allowable amounts in appropriate cir- cumstances. Cohan v. Commissioner, 39 F.2d 540, 543–44 (2d Cir. 1930). However, there must be evidence in the record that provides a rational basis for such an esti- mate. Vanicek v. Commissioner, 85 T.C. 731, 742–43 (1985). We are not obligated to make an estimate under the Cohan rule where there is insufficient record evidence to enable a rational estimate. See Lerch v. Commissioner, 877 F.2d 624, 627–29 (7th Cir. 1989) (refusing to apply the Cohan rule where the taxpayer failed to present evidence to support the claimed deduction), aff’g T.C. Memo. 1987-295. 10

[*10] in the notice of deficiency, are correct, and those determinations are sustained. See Hardy v. Commissioner, 181 F.3d at 1004; Pow- erstein, 102 T.C.M. (CCH) at 506.

V. Accuracy-Related Penalties

The Code imposes a 20% penalty upon the portion of any under- payment attributable to any “substantial understatement of income tax.” See § 6662(a), (b)(2). For a subchapter C corporation such as peti- tioner, a substantial understatement of income tax is an understate- ment that exceeds the lesser of 10% of the tax required to be shown on the return (or, if greater, $10,000) or $10 million. § 6662(d)(1)(B). The Commissioner has no burden of production with respect to the penalty where the taxpayer is a corporation. NT, Inc. v. Commissioner, 126 T.C. 191, 195 (2006) (noting that section 7491(c), which places the burden of production with respect to penalties on the Commissioner, does not ap- ply to corporations, only “individual[s]”).

Petitioner reported tax liabilities of $6,356 and $4,262, respec- tively, on its returns for 2018 and 2019. The notice of deficiency—the adjustments in which we have sustained—determined tax liabilities of $53,202 and $28,056, respectively. This leaves understatements of $46,846 for 2018 ($53,202 − $6,356) and $23,794 for 2019 ($28,056 − $4,262). Each year’s understatement of income tax exceeded the 10% threshold and was thus “substantial.”

No penalty is imposed under section 6662 with respect to any por- tion of an underpayment “if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to [it].” § 6664(c)(1). Petitioner has supplied no evidence to es- tablish reasonable cause or good faith. Quite the contrary, by failing to respond to the Second Request for Admissions, petitioner is deemed to have admitted that it “is liable for the substantial understatement pen- alty . . . in the amounts determined in the statutory notice of deficiency.” We will accordingly sustain the penalties as determined by the Commis- sioner.

To reflect the foregoing,

An appropriate order and decision will be entered for respondent.