John Legoski

• Court: United States Tax Court
• Decided: May 26, 2021
• Docket: 2542-20
• Status: Unpublished

Opinion

T.C. Summary Opinion 2021-15

UNITED STATES TAX COURT

JOHN LEGOSKI, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 2542-20S. Filed May 26, 2021.

John Legoski, pro se.

Nchekube U. Onyima and Brian A. Pfeifer, for respondent.

SUMMARY OPINION

PUGH, Judge: This case was heard pursuant to section 7463 of the Internal

Revenue Code in effect when the petition was filed. 1 Pursuant to section 7463(b),

the decision to be entered is not reviewable by any other court, and this opinion

shall not be treated as precedent for any other case.

Unless otherwise indicated, all section references are to the Internal 1

Revenue Code in effect at all relevant times, and all Rule references are to the Tax

Served 05/26/21 -2-

In a notice of deficiency dated November 4, 2019, respondent determined a

$9,251 deficiency in petitioner’s 2017 Federal income tax and a $1,850 accuracy-

related penalty under section 6662(a). The issues for decision are whether

petitioner: (1) failed to report gross income of $29,501, (2) was entitled to offset

his gross receipts with any cost of goods sold (COGS), and (3) is liable for the

accuracy-related penalty under section 6662(a).

Background

The parties failed to agree to a stipulation of facts before trial. At trial we

admitted into evidence the notice of deficiency, petitioner’s 2017 Form 1040A,

U.S. Individual Income Tax Return, and a letter petitioner received from the

Internal Revenue Service (IRS) dated September 10, 2020. We reserved ruling on

the admission of petitioner’s 2017 Wage and Income Transcript because petitioner

objected that he had not received it before trial, and it was not accompanied by a

business records certification as described in rule 902(11) of the Federal Rules of

Evidence. We do not need to rely upon it for our findings so its admission is moot,

and we will exclude it from evidence.

Court Rules of Practice and Procedure. All monetary amounts are rounded to the nearest dollar. -3-

I. Background

Petitioner resided in California when he timely filed his petition. During

2017 petitioner bought and sold items online, using a drop-shipping model in

which he would purchase an item from a third party such as Walmart or Home

Depot or through the online sales and auction website www.eBay.com, sell the

item online on Amazon, and then arrange for the item to be shipped directly to the

buyer. He would pay for the items through the online payment service PayPal.

When a customer purchased an item from petitioner, Amazon Payments, Inc.

(Amazon Payments), would receive the payment, deduct its fee, and then remit the

remainder to him. In 2017 Amazon Payments paid him $29,501 in connection

with this drop-shipping model. Amazon Payments sent him Form 1099-K,

Payment Card and Third Party Network Transactions, for 2017, reporting the

payments.

II. Petitioner’s Tax Return and Examination

Petitioner prepared (with the assistance of a paid preparer) and timely filed

his 2017 Form 1040A. He reported $29,450 in wages and claimed the standard

deduction. He did not report any of the payments he received from Amazon

Payments because he believed that he did not meet the minimum reporting

threshold for payments from a third-party network. -4-

The IRS Automated Underreporter (AUR) program flagged petitioner’s

2017 Form 1040A because of the mismatch between his reported income and the

$29,501 shown on the Form 1099-K from Amazon Payments. Respondent issued

petitioner a notice of deficiency determining that he had understated his gross

income by the unreported $29,501 and was liable for the section 6662(a) penalty.

Petitioner reported $2,275 of tax on his 2017 Form 1040A and the notice of

deficiency adjusted that amount to $11,526, resulting in the deficiency of $9,251.

Discussion

I. Burden of Proof

Ordinarily, the burden of proof in cases before the Court is on the taxpayer.

Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). The burden of proof

may shift from the taxpayer to the Commissioner in certain circumstances,

including unreported income identified on an information return. See secs.

6201(d), 7491(a); Hardy v. Commissioner, 181 F.3d 1002, 1004-1005 (9th Cir.

1999), aff’g T.C. Memo. 1997-97. Petitioner has acknowledged that he received

the payments from Amazon Payments in the amount reported, and we resolve the

tax treatment of those payments on a preponderance of the evidence in the record.

See Knudsen v. Commissioner, 131 T.C. 185, 189 (2008), supplementing T.C.

Memo. 2007-340; Schank v. Commissioner, T.C. Memo. 2015-235, at *16. -5-

II. Unreported Income

Section 61(a) provides that gross income means “all income from whatever

source derived”. Payments that are “undeniable accessions to wealth, clearly

realized, and over which the taxpayers have complete dominion” are taxable as

income unless an exclusion applies. Commissioner v. Glenshaw Glass Co., 348

U.S. 426, 431 (1955).

The record establishes, and petitioner admits, that he received payments

from Amazon Payments for the items he sold in 2017. He does not dispute the

amount he received. He only contends that when he filed his 2017 Form 1040A he

believed that his gross receipts did not meet the minimum reporting threshold for

third-party payments, although he now admits that he was mistaken. Even if he

were correct about the third-party reporting threshold, he still would have the

obligation to report his gross receipts from his drop-shipping activities; third-party

reporting does not affect that. Accordingly, we hold that the payments were

unreported income and sustain respondent’s inclusion of $29,501 for 2017 in

petitioner’s gross income.

III. COGS

A taxpayer may offset his gross receipts with COGS to compute his gross

income. See Metra Chem. Corp. v. Commissioner, 88 T.C. 654, 661 (1987); secs.

1.61-3(a), 1.162-1(a), Income Tax Regs. Because COGS is an offset against gross -6-

receipts, not a deduction from gross income, it is not subject to the limits on

deductions in section 162. Metra Chem. Corp. v. Commissioner, 88 T.C. at 661.

Nonetheless, any amount reported as COGS must be substantiated. King v.

Commissioner, T.C. Memo. 1994-318, 1994 WL 330613, at *2 (“[A]ny amount

allowed as cost of goods sold must be substantiated.”), aff’d without published

opinion, 69 F.3d 544 (9th Cir. 1995); see sec. 6001; Newman v. Commissioner,

T.C. Memo. 2000-345, 2000 WL 1675519, at *2; sec. 1.6001-1(a), Income Tax

Regs.

We have disallowed all or part of COGS claimed for a tax year when the

taxpayer failed to maintain sufficient reliable records to sustain claimed COGS

offsets. See, e.g., Factor v. Commissioner, 281 F.2d 100, 108, 122 (9th Cir. 1960)

(affirming our decision that a taxpayer failed to maintain records sufficient to

establish business costs and was precluded from “taking any part of * * * [his

business costs] as cost of goods sold”), aff’g T.C. Memo. 1958-94; Chico v.

Commissioner, T.C. Memo. 2019-123, at *25 (sustaining the Commissioner’s

disallowance of all of a taxpayer’s claimed COGS for two tax years because he did

not maintain records of his beginning and ending inventories).

Under the Cohan rule, if a taxpayer can demonstrate that he paid or incurred

an expense but cannot substantiate the precise amount, we generally may estimate

the amount of the expense while “bearing heavily * * * upon the taxpayer whose -7-

inexactitude is of his own making.” Cohan v. Commissioner, 39 F.2d 540, 544 (2d

Cir. 1930); see also Goldsmith v. Commissioner, 31 T.C. 56, 62 (1958) (applying

the Cohan rule to COGS). The Court must have some evidentiary basis for making

an estimate, however. Norgaard v. Commissioner, 939 F.2d 874, 879 (9th Cir.

1991), aff’g in part, rev’g in part T.C. Memo. 1989-390; Vanicek v.

Commissioner, 85 T.C. 731, 742-743 (1985); see also Cohen v. Commissioner,

266 F.2d 5, 11-12 (9th Cir. 1959) (holding that, even if the Commissioner’s

determination to disallow all COGS is “harsh and unrealistic”, any estimate under

Cohan “must be [made] upon the basis of a finding of fact (which may be based

upon approximations)”), remanding T.C. Memo. 1957-172. Otherwise, an

allowance would amount to “unguided largesse”. Norgaard v. Commissioner, 939

F.2d at 879 (quoting Williams v. United States, 245 F.2d 559, 560 (5th Cir. 1957)).

Petitioner has submitted no evidence to substantiate his COGS for 2017,

even though we afforded to him an opportunity to submit documentation after trial.

He has failed to substantiate his COGS or provide us any basis upon which we

could estimate his COGS. We therefore conclude that he is not entitled to offset

his gross receipts with any COGS for 2017.

IV. Section 6662(a) Penalty

Section 6662(a) and (b)(2) imposes a penalty equal to 20% of the portion of

an underpayment of tax required to be shown on the return that is attributable to a -8-

“substantial understatement of income tax.” An understatement of income tax is a

“substantial understatement” if it exceeds the greater of 10% of the tax required to

be shown on the return or $5,000. Sec. 6662(d)(1)(A). Section 7491(c) generally

provides that “the Secretary shall have the burden of production in any court

proceeding with respect to the liability of any individual for any penalty”. See

Higbee v. Commissioner, 116 T.C. 438, 446-447 (2001). 2 A taxpayer may avoid a

section 6662(a) penalty if he can show that he had reasonable cause and acted in

good faith. Sec. 6664(c).

Petitioner’s understatement of income tax of $9,251 is greater than the

greater of $5,000 or $1,153, which is 10% of the amount of tax required to be

shown on his 2017 Form 1040A ($11,526). Therefore, we hold that respondent

has met his burden of production to show that petitioner’s underpayment for 2017

2 The Commissioner’s burden of production may include showing compliance with sec. 6751(b)(1), which requires that the initial determination of any penalty assessment be “personally approved (in writing) by the immediate supervisor of the individual making such determination”. This requirement does not apply to any penalty “automatically calculated through electronic means.” Sec. 6751(b)(2)(B). This Court has held that substantial understatement penalties determined by an IRS computer program without human review are “automatically calculated through electronic means” and are thus exempt from the written supervisory approval requirement. See Walquist v. Commissioner, 152 T.C. 61, 73 (2019). This exception includes returns processed through the AUR program. See Ball v. Commissioner, T.C. Memo. 2020-152, at *12-*13. The penalty here falls within the sec. 6751(b)(2)(B) exception, and respondent was not required to establish that written supervisory approval had been obtained. See id. -9-

was attributable to a substantial understatement. Petitioner bears the burden of

showing that he had reasonable cause for the underpayment and that he acted in

good faith. See sec. 6664(c)(1); Higbee v. Commissioner, 116 T.C. at 446-447.

The decision as to whether a taxpayer acted with reasonable cause and in

good faith is made on a case-by-case basis, taking into account all pertinent facts

and circumstances. See sec. 1.6664-4(b)(1), Income Tax Regs. Generally, the

most important factor is the extent of the taxpayer’s efforts to assess the proper tax

liability. Id.; see Halby v. Commissioner, T.C. Memo. 2009-204, 2009 WL

2924004, at *4.

Petitioner’s failure to investigate the proper tax treatment of his drop-

shipping activities or maintain any documentation of his activities dooms any

argument that he had reasonable cause and acted in good faith. His mistaken belief

that his gross receipts did not meet the third-party minimum reporting threshold

does not excuse his obligation to account for those gross receipts on his own

return. These were not trivial amounts; they even exceeded the wages he reported

on his return. Moreover, while he testified that he lost money overall, he offered

no evidence other than his vague testimony. Accordingly, we sustain the accuracy-

related penalty.

Any contentions we have not addressed we deem irrelevant, moot, or

meritless. -10-

To reflect the foregoing,

An appropriate order and decision

will be entered.