Examiner of the Indiana State Board of Accounts. Id. For the year 1991, this amount was $1.05 per meal. Beginning in 1987, petitioner assumed responsibility for a prisoner meal program (the program) that had been established by one of his predecessors several years earlier. Petitioner continued to operate the program as it had been operated in the past, making no substantive changes to the administration of the program. The program was managed by a kitchen supervisor/cook who was an employee of, and paid by, Howard County. The kitchen supervisor/cook was responsible for preparing menus, ordering food and supplies from vendors, receiving and inspecting deliveries of food and supplies, cooking meals, serving meals to prisoners, and keeping account of the number of meals served to prisoners. The number and the nutritional quality of meals served to county prisoners were governed by standards established by the Indiana Department of Corrections. The sanitary quality of the kitchen facilities, the food preparation techniques, and the food provided to county prisoners were subject to standards imposed by the Howard County Department of Health. Petitioner's duties in connection with the program included approving menus, paying vendors, and signing the required claim forms necessary to receive payment of the meal allow ances. In order to receive the meal allowances, petitioner, on a monthly basis, provided the county auditor with a statement listing the names of prisoners incarcerated in the jail and the number of meals served to each prisoner. Once the statements were certified as correct by the county auditor, the governing Board of Commissioners authorized payment to be made to petitioner. Because he was not required to do so, petitioner did not provide the county auditor with substantiation or verification of the actual costs incurred in feeding county prisoners. Pursuant to the Indiana statutory scheme in effect during the year in issue, petitioner was entitled to retain the difference between the meal allowances he received from the county for feeding the county prisoners and the costs he incurred to do so. In 1991, as county sheriff, petitioner received a $30,566 salary that was appropriately reported as wages on petition ers' 1991 Federal income tax return.3 In addition to his salary, petitioner also received $109,952 as meal allowances from Howard County for providing meals to the prisoners incarcerated in the county jail. Petitioner reported the $109,952 as gross receipts on a Schedule C included with petitioners' 1991 Federal income tax return. The Schedule C reflected that petitioner incurred cost of goods sold in the amount of $68,540. It appears from the Schedule C that the entire amount of the cost of goods sold was composed of purchases made during the year, a conclusion that is also supported by reasonable inferences drawn from petitioner's testimony. After reducing the gross receipts by the cost of goods sold, petitioner computed his gross profit and gross income from the prisoner meal program to be $41,412 and reported that amount on the appropriate lines of the Schedule C. Because no expense deductions were claimed on the Schedule C, $41,412 was also reported as net profit. Petitioners included this $41,412 amount in the amount reported as business income on line 12 of Form 1040 of their 1991 Federal income tax return. OPINION In her amendments to answer respondent has taken the position that petitioner improperly reported the meal allowances as income from a trade or business separate and apart from his employment as Howard County sheriff. According to respondent, by providing meals to the county prisoners, petitioner was discharging a duty imposed upon him as a county employee, not as the proprietor of a separate trade or business. Consequently, respondent contends that the $109,952 received by petitioner as meal allowances should be considered additional compensation paid to petitioner as an employee of Howard County and includable in his income as such. Respondent further contends that any costs incurred by petitioner in connection with the program should be considered employee business expenses, deductible only as miscellaneous itemized deductions on petitioners' Schedule A. Respondent goes on to argue that if the meal allowances are considered additional employee compensation, and the costs 3 There is no dispute that the salary paid to petitioner as county sheriff was paid to him as an employee of Howard County. petitioner incurred in connection with the program are deductible as employee business expenses, the provisions of section 67 (2-percent floor on miscellaneous itemized deductions) and section 55 (alternative minimum tax) result in the increased deficiency now claimed by respondent. Petitioner maintains that he did not receive the meal allowances in return for services provided to Howard County as an employee but rather as an independent contractor. According to petitioners, the income and costs attributable to the program are properly reportable, and were properly reported, on a Schedule C. As an alternative, petitioners also argue that even if the meal allowances were received by petitioner "in an employee capacity, only the net profit earned *** constituted gross income." Although the parties paid some attention to the alternative position advanced by petitioners, almost the entire record and major portions of the briefs relate to the classification issue. In their respective briefs, the parties discussed at length the relevant factors that are usually considered in resolving such issues. Judging from the way that the issues were framed and the arguments presented, it is clear that the parties expect that the classification issue must first be resolved before petitioners' correct 1991 Federal income tax liability can be determined.4 The parties have proceeded in this case upon the apparent assumption that the costs petitioner incurred in connection with the program constitute, within the meaning of sections 62 and 162(a), either trade or business expenses (if the classification issue were resolved in petitioners' favor), or employee business expenses (if the classification issue were resolved in respondent's favor). After carefully considering their arguments in the context of the record, it would appear 4 In her opening brief, respondent framed the classification issue as follows: Whether petitioner, John D. Beatty, as Sheriff of Howard County, Indiana, was an employee for purposes of I.R.C. sections 62 and 67, thereby subjecting his trade or business expenses for 1991 to the two percent floor for miscellaneous itemized deductions or, as contended by petitioner, he was self-employed with respect to the services he performed as Sheriff of Howard County related to the prisoner meal program. If petitioner was self-employed his expenses associated with the prisoner meal program are deductible on Schedule C. Although petitioners did not expressly recite specific issues in their opening brief, see Rule 151(e)(2), it is clear from a review of their brief that petitioners agree with respondent's statement. that the parties' views of the forest have been blocked by the trees. Both parties have ignored the simple fact that petitioner did not claim any section 162(a) deductions with respect to the program. Petitioner did report cost of goods sold on the Schedule C. However, the elements included in a computation of a taxpayer's cost of goods sold do not fall within the category of expenses deductible pursuant to section 162(a).5 This Court has consistently held that the cost of goods sold is not a deduction (within the meaning of section 162(a)), but is subtracted from gross receipts in the determination of a taxpayer's gross income. Max Sobel Wholesale Liquors v. Commissioner, 69 T.C. 477 (1977), affd. 630 F.2d 670 (9th Cir. 1980); Sullenger v. Commissioner, 11 T.C. 1076, 1077 (1948); see sec. 1.61-3(a), Income Tax Regs. With respect to the determination of petitioners' 1991 Federal income tax liability, the critical question is not how petitioner must treat deductions allowable under section 162(a) after the classification issue has been resolved, but rather what petitioner's gross income from the program was in the first instance.6 Limiting our inquiry in this manner, the parties' arguments with respect to the classification issue and treatment of the related section 162(a) deductions simply have no application because no such deductions were claimed. Because section 162(a) deductions are not involved, and because the parties agree that the tax imposed by section 1401 (additional tax imposed upon earnings from selfemployment) is not applicable, it makes no difference in this case whether petitioner reports the income from the program as an independent contractor or as an employee of Howard County. Consequently, we decline to address the question whether petitioner acted as an employee or an independent 5 We do not rely exclusively on petitioner's Schedule C to establish the amount of the cost of goods sold incurred by petitioner in connection with the program. As a general rule we regard the treatment of an item on a return as little more than the taxpayer's claim with respect to the item. See Roberts v. Commissioner, 62 T.C. 834, 837 (1974); Seaboard Commercial Corp. v. Commissioner, 28 T.C. 1034, 1051 (1957). In this case the parties have stipulated that petitioner incurred costs in the amount reported as cost of goods sold, and respondent has offered neither evidence nor argument that petitioner has improperly included such costs in the computation of the reported cost of goods sold. 6 Petitioners touched upon this concept in their alternative argument. However, their position that only the net profit petitioner earned from the program is includable in their gross income, as a general proposition of law, is simply incorrect. Furthermore, their argument was not based upon the proper treatment of cost of goods sold, but rather upon case authority that, for the reasons contained in respondent's reply brief, does not support the argument. contractor of Howard County with respect to the program. Under the circumstances of this case, such a distinction gives rise to no Federal income tax consequences. As we view the case, the determination of petitioner's 1991 gross income from the program is all that is necessary to resolve the controversy between the parties, and that income is easily determined. It is $41,412, computed by subtracting cost of goods sold from the gross receipts petitioner received with respect to the program. That was the amount petitioner was required to report, and did report, on his 1991 Federal income tax return. To reflect the foregoing and the settled issues, Decision will be entered under Rule 155. TRANS CITY LIFE INSURANCE COMPANY, AN ARIZONA OF INTERNAL REVENUE, RESPONDENT Docket Nos. 23678-93, 16934-94. Filed April 30, 1996. P is an insurance company authorized to sell disability and life insurance within the State of Arizona. P's primary and predominant business activity is writing credit life and disability insurance policies. During the subject years, P and G, an unrelated entity, entered into two retrocession (reinsurance) agreements for valid and substantial business reasons. Under the terms of each agreement, G retroceded its position on reinsurance to P, and P agreed to pay G a $1 million ceding commission. The agreements helped P qualify as a life insurance company under sec. 816, I.R.C., which, in turn, allowed P to claim the small life insurance company deduction under sec. 806, I.R.C. Relying on sec. 845(b), I.R.C., R disregarded both of these agreements because, she alleged, the agreements did not transfer to P risks proportionate to the benefits that P derived from the small life insurance company deductions under sec. 806, I.R.C. Held, R may rely on sec. 845(b), I.R.C., prior to the issuance of regulations. Held, further, R committed an abuse of discretion in determining that the agreements had "a significant tax avoidance effect" under sec. 845(b), I.R.C., with respect to P. Held, further, P may amortize each ceding commission over the life of the underlying agreement. |