FROM THE UNITED STATES TAX COURT [Hon. Mary Ann Cohen,
U.S. Tax Court Judge]
Michael S. Lewis, with whom Rath, Young and Pignatelli, P.C.
was on brief, for appellant.
Anthony T. Sheehan, with whom David A. Hubbert, Acting
Assistant Attorney General, and Richard Farber, Attorney, Tax
Division, Department of Justice, were on brief, for appellee.
Lynch, Stahl, and Barron, Circuit Judges.
Inc. appeals from the Tax Court's decision upholding the
Commissioner's notice of deficiency, which, for tax years
2006 through 2008, reduced Transupport's cost of goods
sold, reduced deductions it took for compensation paid to
four employee-shareholders, and assessed a 20%
accuracy-related penalty. See Transupport, Inc.
v. Comm'r (Transupport II),
112 T.C.M (CCH) 580, 2016 WL 6900913 (2016). This is the Tax
Court's second opinion in this case. The first addressed
whether Transupport committed fraud. See Transupport,
Inc. v. Comm'r (Transupport I), 110 T.C.M.
(CCH) 268, 2015 WL 5729787 (2015). We affirm the Tax
Court's decision in Transupport II, as to which
this appeal is taken.
Background A. Transupport's Business
is a wholesaler of engines and engine parts used in military
vehicles. Transupport II, 2016 WL 6900913, at *1.
The portion of its business that is relevant to this dispute
involved buying parts in bulk lots from the U.S. Government
and reselling them. Id. Harold Foote
("Foote") founded Transupport in 1972 and served as
its president and chief executive officer. Id.
Foote's sons, William ("W. Foote"), Kenneth,
Richard, and Jeffrey ("J. Foote"), were
Transupport's only other full-time employees.
Id. Foote owned almost all of Transupport's
stock in 1999, but transferred Transupport's nonvoting
common stock to his sons in equal portions in 2005.
Id. at *2.
relevant times, Elaine Thompson, a certified public
accountant, served as Transupport's outside accountant.
Id. Thompson prepared Transupport's tax returns
based on handwritten summaries of the company's
financials, which were usually prepared by J. Foote.
Id. Thompson did not audit or verify the summaries.
Cost of Goods Sold
taxpayer's income from selling goods is calculated by
taking the income generated by selling goods and subtracting
the amount that the taxpayer paid for those goods, which is
also known as the "cost of goods sold." Treas. Reg.
§ 1.61-3(a) (as amended in 1992). The cost of goods sold
for a given tax year only includes the cost of the goods that
the taxpayer sold in that tax year. See id. Given
this constraint, the cost of goods sold for a given tax year
usually equals the beginning inventory (at cost) plus
inventory purchases and inventory costs, minus the ending
inventory (at cost). Huffman v. Comm'r, 126 T.C.
322, 324 (2006).
used the gross profit method to determine its cost of goods
sold. See Transupport II, 2016 WL 6900913, at *2.
So, instead of calculating the cost of goods sold by tracking
changes in its inventory, Transupport selected a percent
profit that it claimed to make on the sale of goods and used
that figure to generate its cost of goods sold as well as
estimates of its beginning and ending inventory. Id.
Transupport allegedly used a percent profit consistent with
industry standards. See Transupport I, 2015 WL
5729787, at *6. Transupport's cost of goods sold
"varied without explanation" from year to year, and
Transupport kept no records indicating how it selected its
gross profit percentage. Id.
was audited by the IRS in 1984, and "the examining agent
was aware that petitioner did not maintain a physical
inventory of the unsold parts in its warehouse and backed
into the closing inventory, reported in its returns, by using
a percentage of sales as costs of goods sold."
Transupport II, 2016 WL 6900913, at *2. The IRS
expressed disapproval of Transupport's methodology, but
did not meaningfully adjust Transupport's cost of goods
sold for the years under audit. Id. Transupport was
audited again in 1992. Id. The IRS was again aware
of Transupport's practice of not taking a physical
inventory, and again the IRS auditor did not require changes.
continued its use of the gross profit method after the 1992
audit. Its gross profit percentage changed each year, but
remained between 39.3% and 31% from 1999 through 2008.
Id. It reported a cost of goods sold of $6, 951, 132
in 2006; $6, 365, 543 in 2007; and $7, 519, 086 in 2008,
based on gross profit percentages of 33.4%, 39.3%, and 37%,
sons were officers of Transupport, but "performed
various and overlapping tasks for the company, including
tasks that might have been performed by lower level
employees." Id. at *1. Transupport paid each of
Foote's sons $575, 000 in 2006, $675, 000 in 2007, and
$720, 000 in 2008. Id. at *3. Foote made the
compensation decisions alone, without consulting his
accountant. Id. "The only apparent factors
considered in determining annual compensation were reduction
of reported taxable income, equal treatment of each son, and
share ownership." Id. Transupport did not pay
dividends in the years at issue. See id.