Laurel Alterman & William A. Gibson v. Commissioner , 2018 T.C. Memo. 83 ( 2018 )

T.C. Memo. 2018-83UNITED STATES TAX COURT
LAUREL ALTERMAN AND WILLIAM A. GIBSON, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 13666-14. Filed June 13, 2018.
Henry G. Wykowski and Matthew A. Williams, for petitioners.
Cameron W. Carr, Kaelyn J. Romey, and Luke D. Ortner, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
MORRISON, Judge: The petitioners, Laurel Alterman and William A.
Gibson, filed joint income-tax returns for 2010 and 2011. On March 13, 2014, the
respondent (hereinafter, the “IRS”) issued a notice of deficiency to Alterman and
Gibson. The notice of deficiency made adjustments to the income of a Colorado
medical-marijuana business, owned by Alterman, income that was reported on
-2-
[*2] Schedules C, “Profit or Loss From Business”, of both returns. The IRS
determined the following income-tax deficiencies and accuracy-related penalties
under section 6662(a) for tax years 2010 and 2011.1
Penalty
Year Deficiency sec. 6662(a)
2010 $157,821 $31,564
2011 233,421 46,684
Alterman and Gibson filed a petition under section 6213(a) for redetermination of
the deficiencies for both years. We have jurisdiction under section 6214(a).2
After taking into account concessions by the parties described later in the opinion,
here are the issues remaining for decision:
1. What are the amounts of deductible business expenses for Alterman’s
medical-marijuana business for tax years 2010 and 2011? We hold that
petitioners are not entitled to any business-expense deductions. See infra
Part I.
1
Unless otherwise indicated, all references to sections are to the Internal
Revenue Code of 1986, as amended, and all references to Rules are to the Tax
Court Rules of Practice and Procedure. All dollar amounts are rounded to the
nearest dollar.
2
Alterman and Gibson resided in Colorado when they timely filed the
petition. Therefore, any appeal of our decision in this case would go to the U.S.
Court of Appeals for the Tenth Circuit unless the parties designate the Court of
Appeals for another circuit. See sec. 7482(b)(1) and (2).
-3-
[*3] 2. Are Alterman and Gibson entitled to cost-of-goods-sold allowances for the
medical-marijuana business in excess of the amounts conceded by the
IRS in its briefs for tax years 2010 and 2011? The conceded amounts
are $452,292 for 2010 and $232,772 for 2011. We hold that they are
not entitled to additional allowances. See infra Part II.
3. Are Alterman and Gibson liable for accuracy-related penalties under section
6662(a) for tax years 2010 and 2011? We hold that they are liable. See
infra Part III.
FINDINGS OF FACT
The parties stipulated some facts, and those facts are incorporated by
reference. At all times during 2009, 2010, and 2011 Alterman and Gibson were
married and resided in Colorado. They filed joint returns for these years.
Setting Up Altermeds, LLC
During the years at issue, it was not illegal under Colorado law for people to
use marijuana medically and for a medical-marijuana business to sell marijuana.
See Colo. Const. art. XVIII, sec. 14. However, both activities were illegal under
federal law.3 In July 2009, Alterman incorporated Altermeds, LLC.4 She was its
3
Under federal law, marijuana is classified as a Schedule I controlled
substance under the Controlled Substances Act. Pub. L. No. 91-513, secs. 102,
(continued...)
-4-
[*4] sole owner during 2009, 2010, and 2011. Altermeds, LLC, was a separate
entity under Colorado law. For federal tax purposes, it is a disregarded entity,
meaning that it is treated as a sole proprietorship of Alterman. See sec. 301.7701-
2(a), Proced. & Admin. Regs.
Operation of the Medical-Marijuana Dispensary
Around September 2009, Altermeds, LLC, opened a retail store under the
business name “Altermeds”. We refer to this retail store as the “dispensary”. The
dispensary was in Louisville, Colorado, which is near Boulder, Colorado. The
dispensary had regular operating hours of Monday through Saturday from 11 a.m.
to 7 p.m., and on Sunday from 12 p.m. to 5 p.m.
The dispensary sold smokable marijuana, either as prerolled marijuana
cigarettes (i.e., joints) or as dried marijuana buds. It also sold marijuana in edible
form, such as brownies and cakes, and orally-consumed tinctures5. We refer to
3
(...continued)
202, 401, 84 Stat. at 1242, 1247, 1260 (1970) (codified as amended at 21 U.S.C.
secs. 802, 812, 841 (2012)).
4
Before she started Altermeds, LLC, Alterman worked as a real estate agent.
She continued to work as a real estate agent even while owning and working at
Altermeds, LLC.
5
A marijuana tincture is a liquid containing marijuana and is consumed
orally, for example, by adding tincture drops to tea.
-5-
[*5] Altermeds, LLC’s merchandise that contained marijuana, in any of the types
of products mentioned above, as its “marijuana merchandise”.
During 2010 and 2011, the dispensary also sold products that contained no
marijuana, such as pipes, papers, and other items used to consume marijuana. We
refer to this type of merchandise as the “non-marijuana merchandise”. In 2009,
2010, and 2011 Altermeds, LLC, acquired all of its non-marijuana merchandise
from third-party sellers.
Altermeds, LLC, did not provide any services.
Alterman shared the management responsibilities for the dispensary with
her son, Jack Alterman. Jack worked at the dispensary during the years at issue. It
was he who usually made the decisions concerning the purchase of marijuana and
non-marijuana merchandise.6 Alterman was responsible for Altermeds, LLC’s
recordkeeping and finances, such as making bank deposits, paying for
merchandise, and paying expenses.
6
Jack did not work for Altermeds, LLC, continuously during the years at
issue. The record is not clear when Jack was not working for Altermeds, LLC, and
who handled merchandise purchases during his absence.
-6-
[*6] Purchases and Production of Marijuana Merchandise By Altermeds, LLC
During 2009, Altermeds, LLC, did not grow or produce any of its marijuana
merchandise. It bought all of its marijuana merchandise during that year
exclusively from third parties.
During 2010, Altermeds, LLC, continued to acquire marijuana merchandise
from third-party sellers.
Effective September 2010, Colorado required medical-marijuana businesses
to grow at least 70% of the marijuana they sold. Colo. Rev. Stat. sec.
12-43.3-103(b)(2) (2010). Anticipating this 70% requirement, Altermeds, LLC,
began renting a warehouse in June 2010 to grow its own marijuana. The
warehouse, which was in Boulder, was referred to as the “grow site”. When
Altermeds, LLC, first rented the warehouse, the warehouse needed modifications
before it could produce marijuana. Altermeds, LLC, hired Michael Boughton and
Tiffany Weaver in June 2010 to make the necessary modifications. Boughton was
a person who had previously sold marijuana merchandise to Altermeds, LLC. In
September 2010, Altermeds, LLC, also hired Joseph Ingoglia to assist with the
grow site. The only employees who worked at the grow site during 2010 were
Boughton, Weaver, and Ingoglia.
-7-
[*7] While the grow site was being modified, Boughton and Weaver agreed to
sell marijuana merchandise to Altermeds, LLC, on credit, pursuant to an oral
agreement with Alterman. In 2010, marijuana was grown in tents in the
warehouse while the grow site was being modified. The record is unclear as to
whether the marijuana grown in the tents in 2010 was owned by Boughton and
Weaver (who then sold it to Altermeds, LLC, on credit) or by Altermeds, LLC. It
is also unclear whether any of the marijuana grown in the tents during 2010 was
transferred to the dispensary in 2010.
During 2010, Altermeds, LLC, made payments to Boughton, Weaver, and
Ingoglia. The payments to Ingoglia were treated as wage payments by Altermeds,
LLC. The payments to Boughton and Weaver included payments treated by
Altermeds, LLC, for federal tax purposes as wage payments and included
payments not so treated.
In 2011, Altermeds, LLC, continued to purchase marijuana merchandise
from third-party sellers. It is unclear whether Altermeds, LLC, purchased
marijuana from Boughton and Weaver during 2011. From January until May
2011, Altermeds, LLC, made payments to Boughton and Weaver. All of these
payments were treated as wage payments for federal tax purposes by Altermeds,
-8-
[*8] LLC, although the record does not allow us to say how much of the payments
were actually for Boughton’s and Weaver’s services as employees.
Around May 2011, the Colorado Medical Marijuana Board certified that
Altermeds, LLC’s grow site met the structural and mechanical requirements for
marijuana cultivation facilities. Altermeds, LLC, fired Boughton and Weaver
around the same time. Boughton and Weaver credibly testified that when they
were fired, Altermeds, LLC, still owed them for marijuana that they had sold
Altermeds, LLC, on credit. The record does not allow us to calculate the exact
amount owed. Ingoglia continued to work at the grow site for some time after
April 2011 but ended his employment with Altermeds, LLC, before the end of
2011. After Ingoglia stopped working for Altermeds, LLC, it is unclear which
Altermeds, LLC employees worked at the grow site.
Employees of Altermeds, LLC
In 2010 and 2011, Altermeds, LLC, employed Boughton, Weaver, Ingoglia,
and others. The following table summarizes the Forms W-2, “Wage and Tax
Statement”, issued by Altermeds, LLC, for the years at issue:
-9-
[*9] Employee 2011 2012
Jack Alterman $10,800 $32,000
Robert Des Plaines 33,620 48,450
Samuel Feliciano 13,738 8,788
Nathan Leake 15,204 26,100
Noelle Sherman 7,024 5,980
Michael Boughton 10,000 24,250
Tiffany Weaver 2,000 24,250
Joseph Ingoglia 2,800 25,000
Chad Terry 0 4,829
Adam Locy 0 8,745
Jessica Cole 0 9,466
Laurel Alterman 0 14,500
Total 95,186 232,358
The record confirms that Altermeds, LLC, made payments in these amounts to
these persons. The record does not allow us to say how much of these payments
was actually for these persons’ services as employees. The overall amounts
reported on the Forms W-2 as wages equal the wage deductions reported on
Altermeds, LLC’s Schedules C: $95,186 in 2010 and $232,358 in 2011.
Some employees worked at the dispensary, some worked at the grow site,
and some worked at both. Employees at the dispensary sold marijuana
merchandise and non-marijuana merchandise. According to Alterman, employees
at the dispensary also engaged in the “trimming” of marijuana. “Trimming” is the
process of removing stems, seeds, and twigs from a marijuana plant to convert
- 10 -
[*10] marijuana to final, salable form. Alterman estimated that of the time spent
by any particular employee at the dispensary, 40% of that time was occupied by
trimming. We do not believe that employees working at the dispensary spent
substantial time trimming because (1) no evidence other than Alterman’s
testimony supports the assertion that employees working at the dispensary
trimmed marijuana and (2) other witnesses credibly testified that no trimming took
place at the dispensary.
Neither Altermeds, LLC employees nor Alterman recorded the hours
worked by particular employees at the grow site versus the dispensary. Given the
lack of information in the record, we cannot determine what part of the payments
treated by Altermeds, LLC, as employee wages was paid for work performed at
the grow site versus the dispensary.
Records of Altermeds, LLC
During examination, Alterman provided the IRS with receipts that
corroborated some of the expenses paid by Altermeds, LLC, and some of the
purchases of merchandise made by Altermeds, LLC.7 None of these receipts are in
the record.
7
The record does not reveal whether the receipts for purchases of
merchandise given by Alterman to the IRS were receipts for non-marijuana
merchandise or marijuana merchandise or both.
- 11 -
[*11] The record contains Altermeds, LLC’s general ledger for 2010 and 2011.
We first discuss the notations made in the general ledger for purchases of
marijuana and non-marijuana merchandise. We refer to these notations as
“purchase notations”. For each purchase of merchandise, the general ledger
recorded (1) the date, (2) the dollar amount, and (3) the method of payment. Each
purchase of merchandise was given one of four types of descriptions in the general
ledger: (1) smokable, for marijuana buds and pre-rolled joints; (2) edible, for food
items, tinctures, and other infused items; (3) non-marijuana, for papers and other
paraphernalia; and (4) a fourth grouping mysteriously labeled “Meds-C”
(hereinafter, the “undefined merchandise”). The record is unclear as to whether
the undefined merchandise contained marijuana. Sometimes the identity of the
seller was noted in the purchase notation; sometimes it was not. The general
ledger aggregated the total amounts paid for merchandise purchases in a year in
each of the four descriptive categories of merchandise. The general ledger also
aggregated the total amounts paid for all merchandise purchases in a year.
The general ledger tracked the dispensary’s daily receipts in the same four
merchandise categories as the purchase notations. The general ledger does not
reflect the dollar amount of each particular transaction. According to the gross
receipts in the 2010 general ledger, Altermeds, LLC, derived 86.5% of its gross
- 12 -
[*12] receipts from smokable marijuana merchandise, 8.6% from edible marijuana
merchandise, 1.4% from non-marijuana merchandise, and 3.6% from the
undefined merchandise. For 2011, the percentages are 81.7% from smokable
marijuana merchandise, 14.2% from edible marijuana merchandise, 3.6% from
non-marijuana merchandise, and 0.6% from the undefined merchandise.
We now discuss the notations made in the general ledger with respect to
expenses (as distinguished from the purchase of merchandise). For each payment
of an expense, the general ledger shows (1) the date, (2) the dollar amount, (3) the
type of expense (e.g., utilities, rent, etc.), (4) the payment method (i.e., cash,
check, credit card, or electronic funds transfer), and (5) sometimes, the identity of
the payee.
Altermeds, LLC, paid its expenses, and paid for its merchandise, through
various alternative methods: (1) checks from three checking accounts written
directly to vendors, (2) checks from one of three checking accounts (i.e., the
dispensary account, as described below) to Jack, who then paid cash to the vendor,
(3) electronic funds transfers from the three checking accounts, (4) a Visa credit
card, (5) cash paid out of the cash register at the dispensary, or (6) cash paid from
an unknown source.
As discussed above, checks were written from three checking accounts.
- 13 -
[*13] The first checking account was often used to pay the expenses of the
dispensary and for merchandise purchases. We refer to this checking account as
the dispensary account. Checks were written from this account during both 2010
and 2011. The record contains check-register entries for the checks written during
2010. The record contains check-register entries for some, but not all, of the
checks written during 2011. The information in each check-register entry included
the date and the amount of the check. For checks written for merchandise
purchases, the check-register entries also sometimes showed the payees. For
checks written for smokable marijuana, the check-register entries also sometimes
showed the strains and weights of marijuana purchased. For checks written for
edibles and non-marijuana merchandise, the check-register entries also sometimes
showed the quantities purchased. For checks written to pay expenses (as
distinguished from the purchases of merchandise), the check-register entries also
showed the general purposes of the payments (e.g., “Costco - supplies”), and
sometimes showed the payees.
The second checking account was often used to pay the costs of the grow
site and also for merchandise purchases. We refer to this second checking account
as the grow-site account. Although checks were written from this account in 2010
and 2011, there is no check register in the record for this account.
- 14 -
[*14] The third checking account was first used in December 2011. It was
sometimes used to pay expenses and also for merchandise purchases. No check
register is in the record for this account.
In both years at issue, some merchandise purchases and expenses were paid
with electronic funds transfers, made from all three checking accounts.
The record contains banks statements for all three checking accounts. For
the dispensary account, the bank statements cover January 2010 to December
2011. For the grow-site account, the bank statements cover the period from when
the account was opened, June 2010, until December 2011. For the third account,
the bank statements cover December 2011, which is when the account was first
used. The bank statements contain entries corresponding to all checks written
from the three accounts during 2010 and 2011. The bank statements contain
entries corresponding to all electronic funds transfers from all three accounts
during 2010 and 2011.
For electronic funds transfers, the bank statements show the date of each
transfer, the amount of the transfer, and the payee. This set of information is not
more detailed than the corresponding information in the general ledger for the
identical electronic funds transfers. A number of entries recorded in the 2011
general ledger as purchases of smokable marijuana merchandise were paid with
- 15 -
[*15] electronic funds transfers. For some of these entries, the payees were home
improvement stores, such as Home Depot or Lowe’s. We find it improbable that
these stores sold smokable marijuana to Altermeds, LLC.
In both years at issue, some merchandise purchases were made with cash
taken from the dispensary’s register. Altermeds, LLC, kept a daily sales record for
its dispensary. In addition to recording gross receipts (on a daily basis), this daily
sales record noted the amount of cash taken from the register for merchandise
purchases and classified the purchased merchandise into one of the four
merchandise categories. Occasionally additional details concerning the purchased
merchandise were recorded on the daily sales record.8
Some edible marijuana merchandise was purchased during 2011 using cash.
The source of the cash is unclear.
Some merchandise was purchased during 2010 by Jack, using cash that he
acquired when Alterman wrote a check to him. Merchandise was purchased in
this way when the third-party seller did not wish to receive a check. It appears
8
The additional information for these merchandise purchases was no greater
in detail than what Alterman noted in the most detailed check-register entries for
purchases of merchandise (i.e., those check-register entries in which Alterman
noted the strains and weights for smokable marijuana merchandise, and the unit
quantities for edible marijuana and non-marijuana merchandise).
- 16 -
[*16] that the checks used in such an intermediary purchase were drawn from the
dispensary account and were recorded in the check register.
In 2010 and 2011, Altermeds, LLC, used a Visa credit card to pay some of
its expenses and for merchandise purchases. The credit card statements
(hereinafter, the “Visa statements”) in the record were incomplete, as pages were
missing for both years. Alterman wrote on the Visa statements descriptions of the
categories of some of the expenses. Either Alterman or Mark Pendleton,
Altermeds, LLC’s bookkeeper, went through the Visa statements and aggregated
certain expenses or merchandise purchases into single sums. These sums were
then transferred to the general ledger. Thus, for these sums, the general ledger
entries are not specific to particular payments, but rather a group of payments.
Pendleton used Alterman’s initial categorizations of Visa card charges when he
transferred the amounts to the expense or merchandise purchase categories in the
general ledger.
As discussed above, the dispensary used daily sales records that tracked its
gross receipts. Alterman gave the daily sales records to Pendleton to enter into the
general ledger. Pendleton used the daily sales records to prepare monthly
statements, but these monthly statements are not in the record. To prepare the
general ledger, Pendleton relied on documents that Alterman provided to him,
- 17 -
[*17] including daily sales records, Visa statements, and receipts. (It is unclear
whether Alterman provided Pendleton with bank statements. It appears that
Alterman did provide Pendleton with some deposit slips, i.e., records given to
Alterman by the bank when Alterman made a particular deposit. However, no
deposits slips are in the record.) Alterman herself did not verify whether the gross
receipts in the general ledger were consistent with the amounts stated in the daily
sales records.
Tax Reporting
The income of Altermeds, LLC, was reported on Schedules C attached to
Alterman and Gibson’s 2010 and 2011 joint returns.
For 2010, the Schedule C reported gross receipts of $894,922. The
Schedule C reduced gross receipts by cost of goods sold of $464,119. The
Schedule C also reported business-expense deductions of $385,489.
For 2011, the Schedule C reported gross receipts of $657,126. The
Schedule C reduced gross receipts by cost of goods sold of $253,089. The
Schedule C also reported business-expense deductions of $384,817.
The Schedules C reported that cost of goods sold for each year at issue (and
2009) was computed as follows:
- 18 -
[*18] 2009 2010 2011
Inventory at beginning of year 0 0 0
+ Purchases less cost of items $72,564 $476,398 $253,089
withdrawn for personal use
+ Cost of labor 0 0 0
+ Materials and supplies 0 0 0
! Inventory at end of year 0 12,279 0
= Cost of Goods Sold 72,564 464,119 253,089
The Schedules C reported that Altermeds, LLC’s income had been calculated
using the cash method of accounting.
For the 2009 tax year, the first year that Altermeds, LLC, was in business,
Alterman and Gibson’s tax return was prepared by Pendleton.9 Pendleton also
served as Altermeds, LLC’s bookkeeper during 2009. Pendleton had been
preparing returns for Alterman and Gibson in years before 2009.
For the 2010 tax year, Alterman decided instead to use the services of
Comiskey & Co. (hereinafter, “Comiskey”) to prepare the return.10 Comiskey was
recommended to Alterman by Jill Lameroux, another medical-marijuana business
owner. Alterman reviewed the 2010 return before signing it.
9
Pendleton attached a separate Schedule C for tax year 2009 to report the
expenses and income of Alterman’s real estate agent business.
10
Comiskey attached a separate Schedule C for tax year 2010 to report the
expenses and income of Alterman’s real estate agent business.
- 19 -
[*19] For Comiskey’s use in preparing the 2010 return, Alterman provided the
firm with a profit and loss statement and a balance sheet for Altermeds, LLC.11
She did not provide Comiskey with other records, such as the general ledger or
receipts. Comiskey apparently used the profit and loss statement and the balance
sheet to report the various items of cost of goods sold on the Schedule C for
2010.12 In particular:
! $464,119 Total Cost of Goods Sold for 2010. It appears that
Comiskey transferred the profit and loss statement entry “Total Cost
of Goods Sold”, in the amount of $464,119, to the 2010 Schedule C
line item for cost of goods sold, in the same amount. The entry “Total
Cost of Goods Sold” in the profit and loss statement, in the amount of
$464,119, was composed of four subtotals for each of the four
merchandise categories used in the purchase notations in the general
ledger. The record does not reveal how the profit and loss statement
computed the subtotals in each of the four merchandise categories.
11
The record does not reveal who prepared the profit and loss statement or
the balance sheet or what information was used to prepare these two documents.
12
The record includes the profit and loss statement and balance sheet for tax
year 2010. No such documents appear in the record for tax years 2009 and 2011,
and we believe there were no such documents for those years.
- 20 -
[*20] ! $0 Beginning Inventory for 2010. It is unclear how Comiskey
determined the $0 value reported on the 2010 Schedule C for
beginning inventory. The balance sheet for 2010 reflects only one
inventory amount, “Total Inventory”, which is presumably the ending
inventory for 2010. (As explained below, this amount was composed
of subtotals.)
! $12,279 Ending Inventory for 2010. It appears that Comiskey
transferred the entry in the balance sheet, “Total Inventory”, in the
amount of $12,279, to the 2010 Schedule C line item for inventory at
the end of the year, in the same amount. The entry “Total Inventory”
in the balance sheet, in the amount of $12,279, was composed of
three subtotals for smokable marijuana ($9,592), edible marijuana
($1,275), and non-marijuana merchandise ($1,412). It further appears
that the balance sheet entry of $12,279 for “Total Inventory”
corresponds to the same named entry, with the same dollar amount, in
the 2010 general ledger (to which Comiskey did not have access).
The 2010 general ledger entry “Total Inventory” was made up of five
subtotals: smokable marijuana of $9,592; edible marijuana of $1,275;
non-marijuana merchandise of $1,412; undefined merchandise of $0;
- 21 -
[*21] and another category, “Inventory - Other”, of $0. We are unable to
trace the documentary source for the $12,279 amount, or its subtotals,
found in both the general ledger and the balance sheet. It appears that
these amounts ultimately came from an yearend inventory done by
Alterman, who testified that she generally performed a physical
inventory at the end of each year and documented her inventory count
on paper.13 The record does not reveal whether Alterman assigned
cost values to the unit quantities in the physical inventory; even if she
did so, the record does not give us any information about the cost she
assigned to any particular unit in inventory or how she assigned cost
to any particular unit for any unit of purchased marijuana and non-
marijuana merchandise or self-grown marijuana merchandise. Indeed
the record does not have any physical inventory that Alterman
committed to paper.
! $476,398 Purchase Costs for 2010. The record is unclear as to how
the $476,398 amount on the 2010 Schedule C for purchase costs of
13
A physical inventory is a list of the types of products on hand and unit
quantities of each type of product at a given time.
- 22 -
[*22] merchandise was computed.14 We note that the aggregated sum of
“Total Inventory” ($12,279) from the balance sheet and “Total Cost
of Goods Sold” ($464,119) from the profit and loss statement equals
the dollar amount for purchase costs of merchandise on the 2010
Schedule C ($476,398).
For the 2011 return, Alterman decided to have Pendleton prepare the return
instead of Comiskey.15 Alterman’s decision to go back to Pendleton was
motivated by the fact that Comiskey had charged Alterman significantly more for
preparing the 2010 return than Pendleton had charged for the 2009 return. Also
Pendleton told Alterman he had experience preparing returns for other medical-
marijuana businesses. After Pendleton prepared the 2011 return, Alterman
reviewed it. During 2011, Pendleton continued to work as Altermeds, LLC’s
bookkeeper (as he had during 2010, even though he had not prepared the 2010
return). As part of his bookkeeping duties for 2011, he continued to prepare
monthly statements from documentation Alterman provided to him. He also
14
The 2010 general ledger contains a line item (“Total Cost of Goods Sold”)
that appears analogous to the tax-return line item under which the $476,398
amount appears. However, the general-ledger item is a different amount,
$473,485.
15
Pendleton attached a separate Schedule C for tax year 2011 to report the
expenses and income of Alterman’s real estate agent business.
- 23 -
[*23] created the 2011 general ledger. The 2011 general ledger bizarrely recorded
that “Total Inventory” was $12,279, which was the same dollar amount recorded
in the “Total Inventory” entry in the 2010 ledger. The 2011 general ledger also
showed five subtotals. The 2011 general ledger’s description of each subtotal, and
the dollar amount of each subtotal, were the same as in the 2010 general ledger.
We are uncertain why the 2011 Schedule C reported $0 as the beginning
and ending inventories for 2011. That would mean, implausibly, that Altermeds,
LLC, had no merchandise on hand at the beginning and end of 2011. As for the
$253,089 reported on the 2011 Schedule C for purchase costs, we are unsure
where this amount came from. The analogous entry in the 2011 general ledger
recorded the amount as $217,089.
Audit and Statutory Notice of Deficiency
In 2012, the IRS examined Alterman and Gibson’s 2010 and 2011 returns.
It focused exclusively on Altermeds, LLC’s Schedules C. Revenue Agent Kelly
Tipton (hereinafter, “RA Tipton”) was the principal revenue agent who examined
the returns. Alterman provided RA Tipton with documents, such as receipts and
daily sales records.
The notice of deficiency determined that Altermeds, LLC, underreported
gross receipts by $24,663 and $8,359 for 2010 and 2011, respectively. The notice
- 24 -
[*24] allowed costs of goods sold of $388,231 and $1,021 for tax years 2010 and
2011, respectively. Furthermore, the notice disallowed all of Altermeds, LLC’s
Schedule C business-expense deductions for tax years 2010 and 2011 on section
280E grounds, except for depreciation and section 179 expenses in the amounts of
$49,671 and $719 for tax years 2010 and 2011, respectively.
The notice also determined accuracy-related penalties under section
6662(a). RA Tipton made the initial determination to impose accuracy-related
penalties. The determination was approved by RA Tipton’s supervisor, Tommy D.
McDonald. Both the initial determination and the approval of the initial
determination were made before the notice of deficiency was mailed.
Conceded Issues
In the petition, Gibson sought innocent-spouse relief from joint and several
liability for the deficiencies and penalties in the notice of deficiency. At trial,
Gibson conceded his claim for innocent-spouse relief for both years at issue. At
trial, Alterman and Gibson conceded that Altermeds, LLC, underreported its gross
receipts in the amounts stated in the notice of deficiency.
In the IRS’s brief, the IRS increased the amounts of cost of goods sold it
conceded for 2010 from $388,231 in the notice of deficiency to $452,292 and for
2011 from $1,021 to $232,772. The IRS’s brief stated that, for tax year 2010, the
- 25 -
[*25] amount conceded in excess of the cost-of-goods-sold allowance in the notice
of deficiency was made up of the following: $9,580 for rent for the grow site;
$2,010 for utilities at the grow site; $49,671 for depreciation and section 179
expenses (the same amount allowed as a deduction in the notice); and $2,800 for
wages.16 The IRS’s brief stated that, for tax year 2011, the amount conceded in
excess of the cost-of-goods-sold allowance in the notice of deficiency was made
up of the following: $22,407 for rent for the grow site; $10,207 for utilities at the
grow site; $719 for depreciation and section 179 expenses (the same amount
allowed as a deduction in the notice); $25,000 for wages; $295 for testing of
marijuana; and $173,123 for purchases of merchandise.17
OPINION
The taxpayer bears the burden of proving, by a preponderance of the
evidence, that the IRS’s determinations in the notice of deficiency are incorrect.
See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933); Estate of Gilford
v. Commissioner, 88 T.C. 38, 51 (1987). This is the burden of persuasion.
Alterman and Gibson concede that they have the burden of persuasion. With
16
The sum of these amounts ($9,580 + $2,010 + $49,671 + $2,800) and
$388,231 is $452,292.
17
The sum of these amounts ($22,407 + $10,207 + $719 + $25,000 + $295 +
$173,123) and $1,021 is $232,772.
- 26 -
[*26] respect to certain issues involving liability for penalties, the IRS has the
burden of production. This is described in greater detail infra Part III.
I. Business-Expense Deductions
Section 162 allows a deduction for the expenses of carrying on a business.
Sections 167 and 179 allow deductions for depreciation of assets used in a
business. Section 280E, however, provides that no deduction is allowed for an
amount paid or incurred in carrying on a business if the business consists of
trafficking in controlled substances. Although Alterman and Gibson concede that
Altermeds, LLC, trafficked in controlled substances, they contend that it had a
separate business of selling non-marijuana merchandise and that the business-
expense deductions of this separate business are not disallowed by section 280E.
Whether selling non-marijuana merchandise was a separate business from selling
marijuana merchandise is an issue of fact that depends on, among other things, the
degree of economic interrelationship between the two activities. See Californians
Helping to Alleviate Med. Problems, Inc. v. Commissioner (CHAMP), 128 T.C.
173, 183 (2007). Under the circumstances, we hold that selling non-marijuana
merchandise was not separate from the business of selling marijuana merchandise.
First, Altermeds, LLC, derived almost all of its revenue from marijuana
merchandise. Second, the types of non-marijuana products that it sold (pipes and
- 27 -
[*27] other marijuana paraphernalia) complemented its efforts to sell marijuana.18
Altermeds, LLC, had only one unitary business, selling marijuana. See Canna
Care, Inc. v. Commissioner, T.C. Memo. 2015-206, at *12, aff’d, 694 F. App’x
570 (9th Cir. 2017).
If, however, selling non-marijuana merchandise were considered a separate
business, then the expenses of that business would be deductible. See CHAMP,
128 T.C. at 183-185 (stating that caregiving services were a business separate
from provision of marijuana; expenses of providing caregiving services were
deductible). Alterman and Gibson argue that these deductible expense are
$54,707.03 in 2010 and $57,517.93 in 2011. These amounts are equal to 40% of a
list of subtotals in a table in the brief filed by Alterman and Gibson after trial.
Each subtotal bears a vague description, for example “Non-COGS Utilities”.
18
Besides marijuana paraphernalia, Alterman testified that the dispensary
also sold (1) hats and T-shirts with the name and business logo of Altermeds,
LLC, (2) magazines about marijuana, (3) and chicken soup. No documentary
evidence corroborates the existence or extent of these sales. On a preponderance
of evidence, we find that no such items were sold. Furthermore, these types of
products as described by Alterman would generally complement the sales of
marijuana by the dispensary. For example, the hats and T-shirts as described by
Alterman bore the name and business logo of Altermeds, LLC. Thus, even if
Altermeds, LLC, sold such hats and T-shirts, selling those items would have
helped advertise medical marijuana.
- 28 -
[*28] However, the brief fails to adequately explain why any portion of those
subtotals is deductible. In particular the brief fails to:
! identify any specific payments that make up these subtotals;
! provide record citations to support these subtotals; and
! propose findings of facts regarding these subtotals.
Alterman and Gibson’s argument regarding the amounts of business-expense
deductions attributable to a putative second business was not briefed properly.
See Rule 151(e)(3) (brief must include proposed findings of fact with references to
the record); Rule 151(e)(5) (brief must include arguments regarding any disputed
questions of fact). Even if we thought that the sale of non-marijuana merchandise
was a separate business, Alterman and Gibson’s failure to properly brief the
amount of deductions that would be attributable to this business would preclude us
from allowing any deductions for the separate business.19
We now consider whether Alterman and Gibson are entitled to any
business-expense deductions for Altermeds, LLC, apart from the amounts of
19
Although, under the rule in Cohan v. Commissioner, 39 F.2d 540, 543-544
(2d Cir. 1930), the Court can estimate the amount of deductible expenses if there
is a reasonable basis for making such an estimate, Alterman and Gibson do not
contend the Court should employ the Cohan rule to estimate the business expenses
of the putative second business. Furthermore, their brief fails to point to any
evidence that would provide the reasonable basis required for the Court to make
an estimate under the Cohan rule.
- 29 -
[*29] business-expense deductions allegedly attributable to the putative second
business. Because we consider Altermeds, LLC’s business to consist of
trafficking in controlled substances, all such deductions are disallowed by section
280E. Furthermore, Alterman and Gibson, having failed to properly brief their
entitlement to deductions for business expenses they claim relate to Altermeds,
LLC’s putative second business, have also failed to properly brief their entitlement
to deductions for any other business expenses of Altermeds, LLC. They did not
even allege the amounts of such deductions, much less any specific payments,
provide record citations, or propose findings of fact. Therefore, we conclude
Alterman and Gibson are not entitled to any business-expense deductions for
Altermeds, LLC.20
20
This conclusion holds even for depreciation and sec. 179 expenses.
Alterman and Gibson claimed deductions of $119,639 for 2010 and $11,739 for
2011 for depreciation and sec. 179 expenses and, as discussed above, the notice of
deficiency partially allowed deductions for depreciation and sec. 179 expenses
($49,671 and $719 for 2010 and 2011, respectively). In their post-trial brief,
Alterman and Gibson argue that they are entitled to deduct business expenses for a
second business that did not consist of trafficking in controlled substances, but
they do not identify among these business expenses any depreciation and sec. 179
expenses. Furthermore, they argue that the deductions they claimed for
depreciation and sec. 179 expenses on their Schedules C for 2010 and 2011 should
be recharacterized as allowances for cost of goods sold of Altermeds, LLC, in its
business of trafficking in controlled substances. The IRS argues in its post-trial
brief that sec. 280E disallows all business-expense deductions (including
depreciation and sec. 179 expenses) for Altermeds, LLC. Furthermore, it
(continued...)
- 30 -
[*30] II. Cost of Goods Sold
Alterman and Gibson argue they are entitled to cost-of-goods-sold
allowances in excess of the amounts the IRS conceded in its briefs. The individual
income tax is computed on the basis of taxable income. Sec. 1. Taxable income is
equal to gross income minus deductions. Sec. 63. Cost of goods sold is a
reduction made in the course of computing gross income. Sec. 1.61-3(a), Income
Tax Regs. It is not a deduction, see Max Sobel Wholesale Liquors v.
Commissioner, 69 T.C. 477 (1977), aff’d, 630 F.2d 670 (9th Cir. 1980), and
therefore it is not disallowed by section 280E, Olive v. Commissioner, 139 T.C.
19, 32 (2012), aff’d, 792 F.3d 1146 (9th Cir. 2015); sec. 1.162-1(a), Income Tax
Regs.
As the taxpayers, Alterman and Gibson must prove the amounts allowable
as cost of goods sold. See Rule 142(a). A taxpayer is required to maintain
20
(...continued)
concedes that Alterman and Gibson are entitled to cost-of-goods-sold allowances
in the amounts allowed in the notice of deficiency for depreciation and sec. 179
expenses and that the amounts are additional to the allowances for cost of goods
sold allowed in the notice of deficiency. Because Alterman and Gibson failed to
brief their entitlement to deductions for business expenses related to Altermeds,
LLC, including depreciation and sec. 179 expenses, and because they argue that
the amounts of deductions they reported for depreciation and sec. 179 expenses
should be recharacterized as cost of goods sold, they have waived any argument
that they are entitled to the deductions allowed by the notice of deficiency for
depreciation and sec. 179 expenses.
- 31 -
[*31] sufficient permanent records to substantiate income, including cost of goods
sold. See sec. 6001; sec. 1.6001-1(a), (d), Income Tax Regs. However, the Court
may estimate cost of goods sold under a variation of the Cohan rule even when
cost of goods sold is not fully substantiated, provided that there is a reasonable
basis for making such an estimate. Cohan v. Commissioner, 39 F.2d 540, 543-544
(2d Cir. 1930); Vanicek v. Commissioner, 85 T.C. 731, 743 (1985); see Olive v.
Commissioner, 139 T.C. at 34.
Properly computed, cost of goods sold equals
! the cost of merchandise on hand at the beginning of the taxable year
(“beginning inventory”), sec. 1.471-3(a), Income Tax Regs.,
! plus the cost of merchandise purchased since the beginning of the
taxable year (“purchase costs”), id. para. (b),
! plus the direct and indirect cost of producing merchandise
(“production costs”), id. para. (c), sec. 1.471-11, Income Tax Regs.,
! minus the cost of inventory on hand at the end of the tax year
(“ending inventory”), sec. 1.471-1, Income Tax Regs.
- 32 -
[*32] Inventories must be recorded in a legible manner, properly computed and
summarized, and these inventory records must be preserved by the taxpayer. Sec.
1.471-2(e), Income Tax Regs.21
Alterman and Gibson contend that the cost-of-goods-sold allowances for
2010 and 2011 are:
2010 2011
Cost of merchandise purchased during the year $464,119 $253,089
Cost of merchandise produced during the year + 136,094 + 164,431
Total cost of goods sold 600,213 417,520
21
For businesses for which production, purchase, or sale of merchandise is
an income-producing factor, inventories at the beginning and end of each taxable
year are necessary. Sec. 1.471-1, Income Tax Regs. Altermeds, LLC, was such a
business, and therefore was required to use beginning and ending inventories. At
one point during discovery, Alterman and Gibson asserted that Rev. Proc. 2000-
22, 2000-1 C.B. 1008, as modified and superseded by Rev. Proc. 2001-10, 2001-1
C.B. 272, relieved Altermeds, LLC, of the obligation to account for inventories.
In response, the IRS filed a memorandum taking the position that Alterman and
Gibson misinterpreted Rev. Proc. 2000-22, supra. Alterman and Gibson did not
rely on Rev. Proc. 2000-22, supra, after that. For example, they did not cite Rev.
Proc. 2000-22, supra, in their briefs. Therefore, they have waived any argument
that Rev. Proc. 2000-22, supra, relieved Altermeds, LLC, of the obligation to
account for inventories.
The Schedules C for Altermeds, LLC, reported that its income was
calculated using the cash method of accounting. In certain situations, farmers may
use the cash method of accounting as an alternative to the inventory method.
Kennedy v. Commissioner, 89 T.C. 98, 103 (1987). Alterman and Gibson have
not contended that they are farmers for this purpose and therefore have waived any
argument that they were entitled to use the cash method of accounting as farmers.
- 33 -
[*33] By comparison the IRS concedes that the cost-of-goods-sold allowances for
2010 and 2011 are:22
2010 2011
Total cost of goods sold $452,292 $232,772
The IRS makes a threshold argument that the method of computing cost of
goods sold urged by Alterman and Gibson is improper because it does not account
for beginning and ending inventories. That their method ignores beginning and
ending inventories can be seen from the formula supra p. 31: cost of goods sold
equals beginning inventory, plus purchase costs, plus production costs, minus
ending inventory. Alterman and Gibson’s argument for cost-of-goods-sold
allowances relies entirely on purchase costs and production costs. It assumes that
cost of goods sold equals purchase costs plus production costs. Thus, their
method leaves out beginning inventory and ending inventory. Such a method is
indeed improper. See sec. 1.471-1, Income Tax Regs.
As an alternative argument, Alterman and Gibson contend that the Court
should estimate, under Cohan, the relevant beginning and ending inventories for
each year. This task is impossible on this record. To calculate cost of goods sold
for 2010, the relevant beginning inventory is the inventory on hand at the
22
For the calculation of these amounts, see supra notes 16 and 17.
- 34 -
[*34] beginning of 2010, which is by definition the ending inventory for 2009.
Fox Chevrolet, Inc. v. Commissioner, 76 T.C. 708, 722 (1981) (“Bearing in mind
that beginning inventory for any given year is equal to the ending inventory for the
prior year, it is easy to see that an error in any year carries forward to every
subsequent year.”). To estimate ending inventory for 2009, we would first need to
estimate the types of products and unit quantities on hand at the end of 2009. This
is called a physical inventory.23 There is no information in the record regarding
the physical inventory on hand at the end of 2009. Even if we had a physical
inventory for the end of 2009, we would need to assign a cost to each unit. Ending
inventory for 2009 is composed solely of merchandise purchased during 2009
because Altermeds, LLC, did not produce any marijuana in 2009 and because it
began its operations in 2009. There is no information in the record regarding the
cost of merchandise purchased by Altermeds, LLC, in 2009.24 Alterman and
23
A physical count requires a determination of how many types of products
are in inventory. See Stephen F. Gertzman, Federal Tax Accounting, para.
6.08[2][a] (2d ed. 1993). Although we generally understand that the dispensary
sold products like buds, joints, and brownies (and therefore probably had these
products on hand at the end of 2009), we do not know enough to determine
whether each of these should be considered a product type or whether each of
these groups should be broken into different product types.
24
Alterman and Gibson attached a Schedule C for Altermeds, LLC, to their
2009 return. They reported $0 as beginning inventory, which is the correct
(continued...)
- 35 -
[*35] Gibson have pointed to no evidence in the record to give us a reasonable
basis for estimating the ending inventory for 2009.25 In conclusion, there is no
way for us to estimate the ending inventory for 2009 and therefore the beginning
inventory for 2010.
It is also impossible to estimate the ending inventory for 2010. We would
first need to estimate the physical inventory at the end of 2010, i.e., unit quantities
by product type. Then, using a cashflow assumption (such as first-in-first-out), we
would assign a cost value to each unit of physical inventory at the end of 2010 by
importing a cost value from (1) a unit in the beginning inventory for 2010, (2) a
unit purchased during 2010, or (3) a unit produced during 2010. Secs. 1.471-1,
1.471-3, 1.471-11, Income Tax Regs.; see also Stephen F. Gertzman, Federal Tax
Accounting, paras. 6.06, 6.07, and 6.08 (2d ed. 1993). As explained above,
24
(...continued)
amount because Altermeds, LLC, started operating in 2009. They reported no
production costs. They reported purchase costs of $72,564 but the record does not
contain evidence to show how this dollar amount was calculated, such as receipts
for merchandise purchases, a physical inventory or other documentation. Ending
inventory for 2009 was reported as $0. We find the ending inventory amount
unreliable. If Altermeds, LLC’s inventory was $0 at the end of 2009, it would not
have had any inventory on hand. We find this unlikely. Alterman and Gibson
calculated cost of goods sold using only purchase costs, ignoring ending
inventory. This is incorrect.
25
They reported on Altermeds, LLC’s 2010 Schedule C the beginning
inventory as zero, but they do not argue that this amount is correct.
- 36 -
[*36] however, we do not have the cost values for units in the beginning inventory
for 2010.26 And, for units purchased during 2010, at most we have aggregate cost
data, rather than the cost of any particular unit of merchandise.27 And, for units
produced during 2010, we cannot even tell from the record whether any units of
any type of marijuana merchandise were produced by Altermeds, LLC, during
2010.
To estimate ending inventory for 2011, there are similar problems that are
magnified by the lack of data from prior years. Furthermore, by 2011, Altermeds,
26
The following hypothetical illustrates the importance of knowing the cost
of beginning inventory. Suppose the following:
! In 2009, Altermeds, LLC, buys three joints at different times during
the year for $3, $4, and $5, respectively.
! In 2009, it sells none of these joints. So all three joints are in the
ending inventory in 2009 (and therefore are in beginning inventory
for 2010).
! In 2010, Altermeds, LLC, sells two of the three joints.
If we use the first-in-first-out cashflow assumption, then the two joints sold in
2010 were the $3 and $4 joints. The $5 joint remains in inventory in 2010 and it
has an inventory cost of $5. The $5 amount is used to compute ending inventory
for 2010 (along with the cost of all other products in ending inventory). Thus, we
can compute ending inventory for 2010 only if we know beginning inventory for
2010.
27
The check-register entries contain the most detail in the record concerning
merchandise purchases. Nevertheless, we cannot determine unit quantities or
assign unit costs as the entries are minimally informative and incomplete and
cover only a fraction of the merchandise purchases.
- 37 -
[*37] LLC, was growing some of its own marijuana, but the record does not
include inventory documentation for self-grown marijuana.
It is improper in this case for the Court to estimate beginning and ending
inventories. The Court need not reach the question of the cost of purchasing
merchandise or the cost of producing merchandise during the years at issue. These
amounts are relevant to cost of goods sold only when they are used in combination
with beginning and ending inventory.28
We hold that the cost-of-goods-sold allowances for Altermeds, LLC, are
$452,292 for 2010 and $232,772 for 2011, which are the amounts conceded by the
IRS.29
28
As a further alternative, Alterman and Gibson contend that the Court
should determine cost of goods sold for each year by multiplying Altermeds,
LLC’s gross receipts for each year by a ratio similar to the ratio used in Olive v.
Commissioner, 139 T.C. 19 (2012), aff’d, 792 F.3d 1146 (9th Cir. 2015). In Olive
v. Commissioner, 139 T.C. at 35, we estimated the costs of goods sold for a
medical-marijuana business by multiplying its gross receipts by a comparative
ratio of gross receipts to costs of goods sold. We determined the comparative ratio
of gross receipts to costs of goods sold from the testimony of two expert
witnesses, Henry Levy and Dale Gieringer. Id. Alterman and Gibson called Levy
as an expert witness. However, the Court ruled that his testimony was
inadmissible and excluded it from evidence. Unlike the record in Olive, the record
in this case contains no evidence to support a ratio comparison with other medical-
marijuana businesses.
29
It appears that the IRS determined the amounts it conceded by adding
production costs to purchase costs. However, it does not concede that this is the
(continued...)
- 38 -
[*38] III. Section 6662(a) Penalties
The IRS takes the position that Alterman and Gibson are liable for 20%
accuracy-related penalties under section 6662(a) because the underpayments of tax
for 2010 and 2011 are attributable to negligence or, alternatively, to substantial
understatements of income tax. See sec. 6662(b)(1) and (2).
Section 6662(a) imposes a penalty equal to 20% of an underpayment that is
attributable to negligence, or to a substantial understatement of income tax, or to
various other causes. Sec. 6662(b). An understatement of income tax is generally
the difference between the correct tax and the tax reported on the return. Sec.
6662(d)(2)(A). An understatement is substantial if it exceeds the greater of “(i) 10
percent of the tax required to be shown on the return for the taxable year, or (ii)
$5,000.” Sec. 6662(d)(1)(A). Negligence includes any failure by the taxpayer to
keep adequate books and records or to substantiate items properly. Sec. 1.6662-
3(b)(1), Income Tax Regs. The penalty is not imposed on any portion of an
underpayment if there was a reasonable cause for such portion and the taxpayer
acted in good faith with respect to that portion. Sec. 6664(c)(1). Section
6751(b)(1) provides that certain penalties cannot be assessed unless the initial
29
(...continued)
proper method of calculating cost of goods sold.
- 39 -
[*39] determination of the assessment is personally approved in writing by the
immediate supervisor of the individual making the determination.
The IRS has the burden of producing evidence that it is appropriate to
impose the penalty. Sec. 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446
(2001). If the IRS has met its burden of production, the taxpayer has the burden of
persuading the Court that it is inappropriate to impose the penalty, for example,
because a portion of the underpayment was due to reasonable cause and good
faith. Higbee v. Commissioner, 116 T.C. at 447.
The IRS’s burden of producing evidence includes producing evidence that
there was a substantial understatement of income tax. Avrahami v. Commissioner,
149 T.C. __, __ (slip op. at 98) (Aug. 21, 2017). The taxes reported on the returns
are determinable because the returns are in the record. Whether substantial
understatements of income tax exist, and if so, in what amounts, will depend upon
the recalculation of Alterman and Gibson’s 2010 and 2011 tax liabilities taking
into account (1) their concession regarding underreported gross receipts and
(2) the holdings in this opinion. We leave these calculations to the parties under
Rule 155.
Regardless of whether the underpayments were due to substantial
understatements of income tax, we hold that they were due to negligence.
- 40 -
[*40] Alterman and Gibson did not keep adequate records to compute reliable
beginning and ending inventories for Altermeds, LLC. Alterman and Gibson
acted negligently by failing to keep adequate books and records. See sec. 1.6662-
3(b)(1), Income Tax Regs. The IRS has met its burden of producing evidence that
the underpayments are due to negligence. Alterman and Gibson have not
persuaded us otherwise.
In a deficiency case, the IRS’s burden of production includes the burden of
producing evidence that it complied with the supervisory-approval requirement of
section 6751(b)(1) for certain penalties. See Graev v. Commissioner, 149 T.C. __
(Dec. 20, 2017), supplementing and overruling in part 147 T.C. 460 (2016). The
IRS satisfied this burden. It introduced a penalty approval form bearing RA
Tipton’s name and the signature of RA Tipton’s supervisor demonstrating his
approval. The supervisor testified that RA Tipton had initially determined the
penalties and that the supervisor had approved the initial determination.
At trial, Alterman and Gibson objected to the admissibility of the penalty
approval form. They argued that the penalty approval form contains RA Tipton’s
expert opinions and that these opinions could be presented only through expert
testimony. (RA Tipton testified at trial as a fact witness, not an expert witness.).
We overruled the objection and admitted the penalty approval form into the
- 41 -
[*41] record. In post-trial briefing, Alterman and Gibson urge us to reconsider the
admissibility of the penalty approval form on the same grounds they gave for their
objection at trial. Their objection was meritless. The IRS offered the penalty
approval form to show that RA Tipton had initially determined that the penalties
should be imposed (and that his supervisor approved the initial determination), not
to show that the penalties are appropriate.
Alterman and Gibson argue that the IRS did not comply with the
supervisory-approval requirement because RA Tipton did not allow petitioners
enough time to fully present a reasonable-cause defense to the accuracy-related
penalty before he submitted their case to his supervisor. But section 6751(b)(1)
requires only that the penalty be “personally approved (in writing) by the
immediate supervisor”. It does not require the supervisor to follow any specific
procedure in determining whether to approve the penalty.
Alterman and Gibson argue that there was reasonable cause for their
underpayments and that they acted in good faith. Taxpayers can demonstrate
reasonable cause and good faith if they reasonably relied on advice about the
appropriate tax treatment of their business. Sec. 1.6664-4(c)(1), Income Tax Regs.
However, Alterman and Gibson neither sought or received advice from Comiskey
and Pendleton regarding appropriate inventory accounting or the effect of section
- 42 -
[*42] 280E. Sec. 1.6664-4(c)(2), Income Tax Regs. Furthermore, Alterman and
Gibson did not ask whether businesses that sell medical marijuana or violate
federal drug trafficking laws are taxed differently from other businesses. This lack
of inquiry evinces their lack of interest in complying with the federal tax laws.
Sec. 1.6664-4(b)(1), Income Tax Regs. (providing that the most important factor
in determining whether a taxpayer acted with reasonable cause and in good faith is
the extent of the taxpayer’s effort to assess his or her proper tax liability for the
year).
Alterman and Gibson did not act with reasonable cause and in good faith
with respect to the 2010 and 2011 underpayments. Therefore, we hold they are
liable for the accuracy-related penalty for each year.
In reaching our holdings, we considered all arguments made, and, to the
extent not mentioned, we conclude that they are moot, irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered under
Rule 155.