ATTORNEYS FOR PETITIONER:                      ATTORNEYS FOR RESPONDENT:
RANDAL J. KALTENMARK                           CURTIS T. HILL, JR.
ZIAADDIN MOLLABASHY                            ATTORNEY GENERAL OF INDIANA
BARNES & THORNBURG LLP                         WINSTON LIN
Indianapolis, IN                               PARVINDER K. NIJJAR
                                               DEPUTY ATTORNEYS GENERAL
                                               Indianapolis, IN

                                                                        FILED
                                IN THE                             Sep 05 2017, 4:27 pm

                                                                        CLERK
                          INDIANA TAX COURT                         Indiana Supreme Court
                                                                       Court of Appeals
                                                                         and Tax Court




JOHN AND SYLVIA                               )
VON ERDMANNSDORFF,                            )
                                              )
      Petitioners,                            )
                                              )
                     v.                       ) Cause No. 49T10-1112-TA-00093
                                              )
INDIANA DEPARTMENT OF STATE                   )
REVENUE,                                      )
                                              )
      Respondent.                             )


                 ON APPEAL FROM A FINAL DETERMINATION OF
                 THE INDIANA DEPARTMENT OF STATE REVENUE

                                FOR PUBLICATION
                                September 5, 2017

WENTWORTH, J.

      John and Sylvia von Erdmannsdorff have appealed the Indiana Department of

State Revenue’s Proposed Assessments of adjusted gross income tax (AGIT) for the

2000 through 2009 tax years.       This matter concerns whether the Department’s

Proposed Assessments based on the best information available are valid in light of the
von Erdmannsdorffs’ contrary information.1           The Court finds in favor of the von

Erdmannsdorffs.

                                            FACTS

       During the years at issue, Mr. von Erdmannsdorff owned and operated a new

and used bookstore as a sole proprietorship in the college town of West Lafayette,

Indiana.   (See Stipulation of Facts (“Stip.”) ¶¶ 1-2; Trial Tr. at 71-72, 128, 145.)

Between 2000 and 2006, the sole proprietorship was operated from several adjacent

buildings under the distinct business names of “Von’s Shops” and “Von’s Video and

Comics.” (See, e.g., Stip. ¶¶ 1, 22(B)-(C), Exs. 17-J(B)-(C); Trial Tr. at 76.) Von’s

Shops was located within four buildings and sold an assortment of new and used books,

music in vinyl and CD formats, beads, greeting cards, rocks, and other odds and ends.

(See Stip. ¶ 2; Second Stipulation of Facts (“Sec. Stip.”) ¶ 1, Ex. 22-J at 530; Trial Tr. at

72-73, 76.) Von’s Video and Comics, located in a building adjacent to Von’s Shops,

purchased and sold comic books, VHS tapes, and DVDs and, in addition, rented VHS

and DVD movies. (See Trial Tr. at 75-76; Stip. ¶¶ 22(B)-(C), Exs. 17-J(B)-(C).) In

2006, Von’s Video and Comics closed and its inventory was moved to Von’s Shops.

(See Stip. ¶¶ 22(B)-(C), 22(F), Exs. 17-J(B)-(C), 17-J(F).) Consequently, Von’s Shops

began to rent VHS and DVD movies and sell comic books, VHS tapes, and DVDs. (See

Stip. ¶ 22(L), Ex. 17-J(L); Trial Tr. at 75-80.)

       In January of 2010, while auditing Von’s Shops for the 2007 and 2008 tax years,

the Department asked to inspect Von’s Shops’ general ledgers, federal and state

income tax returns, and any supporting state tax workpapers. (See Stip. ¶¶ 3, 15, Exs.

1
  Portions of the evidence are confidential information. Accordingly, the Court will provide only
that information necessary for the reader to understand its disposition of the issues presented.
See generally Ind. Administrative Rule 9.
                                               2
1-J, 11-J at 43.) Mr. von Erdmannsdorff replied that because his business had “been

operating in the red for years[,]” he did not owe any income tax and therefore had not

filed tax returns. (See Stip. ¶¶ 15, 18, Exs. 11-J at 45, 14-J at 96; Trial Tr. at 86-87.)

The Department explained that Mr. von Erdmannsdorff needed to file federal and state

income tax returns for the years at issue as soon as possible and expanded the scope

of its audit to include the 2000 through 2006 and 2009 tax years. (See Stip. ¶ 15, Ex.

11-J at 45, 47.)

        By the end of May of 2010, Mr. von Erdmannsdorff had provided the Department

with access to, or copies of, Von’s Shops’ general ledgers, checkbook registers, payroll

data, and expense reports for each of the years at issue. (See Stip. ¶¶ 10, 15, Exs. 4-J

to 6-J, 11-J at 47-50.) Mr. von Erdmannsdorff, however, did not provide the Department

with copies of Von’s Shops’ inventories, which would have been used to calculate its

annual cost of goods sold (hereinafter, “COGS”),2 because Mr. von Erdmannsdorff did

not take inventories during the years at issue. (See Stip.¶ 15, Ex. 11-J at 47-52; Trial

Tr. at 27-28, 36, 117, 161-63.) Lacking actual inventory information, the Department

determined that it would rely on the general information contained in the category

entitled “sole proprietorship sporting goods-hobby-book-music store” from BizStats’3 for

2006.    (See, e.g., Stip. ¶¶ 9, 11-12, Exs. 3-J, 7-J, 8-J at 35.)          Accordingly, the

Department used the “cost of sales financial ratio of 56.48%” from this BizStats category


2
  “Cost of goods sold” refers to the number of inventory items “that are being removed or sold
as part of the normal business cycle[.]” (Trial Tr. at 27-28.) “Cost of goods sold generally is
computed under a formula that starts with beginning inventory, adds purchases, [and then]
subtracts ending inventory[.]” (Trial Tr. at 28.)
3
     “BizStats is an online provider of free business statistics and financial ratios.” von
Erdmannsdorff v. Indiana Dep’t of State Revenue, 53 N.E.3d 621, 623 n.3 (Ind. Tax Ct. 2016)
(citation omitted).
                                              3
as the best information available to estimate Von’s Shops’ annual cost of goods sold.

(See Stip. ¶¶ 9, 16, Ex. 3-J, Confd’l Ex. 12-J at 66-67, 69; Trial Tr. at 162-63.)

       In June of 2010, the Department explained to Mr. von Erdmannsdorff that if it did

not receive all of his completed tax returns by July 30, it would issue Proposed

Assessments against the von Erdmannsdorffs based on the best information available

to it. (See Stip. ¶¶ 14-15, Exs. 10-J, 11-J at 51-52.) After this deadline passed, the

Department issued an Investigation Summary to the von Erdmannsdorffs, detailing the

basis and computation of Proposed Assessments using BizStats as the best information

available. (See Stip. ¶ 16, Confd’l Ex. 12-J.) On October 26, 2010, the Department

issued the Proposed Assessments imposing approximately $245,000 in AGIT, interest,

and penalties for the years at issue. (See Stip. ¶ 17, Confd’l Ex. 13-J.)

       In December of 2010, the von Erdmannsdorffs protested the Proposed

Assessments. (See, e.g., Stip. ¶ 18.) At that time, the von Erdmannsdorffs presented

the Department with copies of their federal and state income tax returns for the years at

issue. (See Stip. ¶¶ 18, 18(A)-(T), Ex. 14-J, Confd’l Exs. 14-J(A)-(T).) In addition, the

von Erdmannsdorffs provided estimates of the annual COGS derived from

“reconstructed” inventories for each of the years at issue. (See, e.g., Stip. ¶¶ 18(U)-

(W), 22(S), Confd’l Exs. 14-J(U)-(W), Ex. 17-J(S).)

       The von Erdmannsdorffs’ estimate of the inventory for the 2000 tax year was

based on the recollections of Mr. von Erdmannsdorff and his long-time employees

together with the measurements of spaces that housed the inventory within Von’s

Shops. (See, e.g., Stip. ¶ 18(V), Confd’l Ex. 14-J(V); Trial Tr. at 91-96, 134-37, 149.)

For instance, the inventories of new books and CDs were developed by approximating



                                             4
the historical placement of shelves and bins, confirming those placements by measuring

floor space, estimating the historical inventory held on the shelves and bins, and then

multiplying that total by the item’s average price.      (See, e.g., Stip. ¶¶ 18(V), 22(I),

Confd’l Ex. 14-J(V); Ex. 17-J(I); Trial Tr. at 91-96.)

       The inventory for the 2009 tax year was developed somewhat differently, using

linear measurement and physical count methodologies. (See Stip. ¶ 18(W), Confd’l Ex.

14-J(W); Trial Tr. at 87-92.) More specifically, an inventory of books was developed by

first estimating the number of new or used books held on the shelves based on either

the measurements of the shelves and the thickness of varying genres of new books or

the measurements of the shelves alone, and then, multiplying each total by the average

price of a book. (See Stip. ¶ 18(W), Confd’l Ex. 14-J(W) at 245; Trial Tr. at 89-92.) The

inventory of the remaining items was developed by physically counting or estimating the

number of items and then multiplying each total by the item’s average price. (See Stip.

¶ 18(W), Confd’l Ex. 14-J(W) at 244, 246-47; Sec. Stip. ¶¶ 8-9, Exs. 29-J ¶¶ 10-11, 30-J

at 19-20, 39-40; Trial Tr. at 88-89.)

       Finally, the inventories for the 2001 through 2008 tax years were extrapolated

from the 2000 and 2009 inventories, using straight-line adjustments to track the regular

flow of inventory over the ten-year assessment period. (See Stip. ¶¶ 19(A), 22(S), Exs.

15-J(A), 17-J(S); Trial Tr. at 41-46, 95-96, 115.) Indeed, the underlying assumption

supporting the use of straight-line adjustments was that the incremental changes to the

amount or value of inventory remained steady from year-to-year; for instance, if the

amount of inventory increased by $100,000 over the ten-year period, “then the

increment would be $10,000 per year.” (See Trial Tr. at 43.) In addition, the 2001



                                              5
through 2008 inventories incorporated specific short-term adjustments for any period

where there was a significant change in the amount or value of inventory items. (See,

e.g., Stip. ¶ 22(S), Ex. 17-J(S); Trial Tr. at 43-44, 95-96.)

       On July 20, 2011, after conducting a hearing, the Department issued a Letter of

Findings denying the von Erdmannsdorffs’ protest. (Stip. ¶ 23, Ex. 18-J.) Then, on

October 20, 2011, the Department denied the von Erdmannsdorffs’ request for

rehearing. (Stip. ¶¶ 24-25, Exs. 19-J, 20-J.)

       On December 16, 2011, the von Erdmannsdorffs initiated this original tax appeal.

The Department subsequently filed a motion for summary judgment, asserting that it

was entitled to judgment as a matter of law because the von Erdmannsdorffs’

reconstructed inventories, and thus their COGS estimates, lacked probative value. See

von Erdmannsdorff v. Indiana Dep’t of State Revenue, 53 N.E.3d 621, 625 (Ind. Tax Ct.

2016). The von Erdmannsdorffs filed a counter-motion for partial summary judgment,

asserting that the Department made certain errors in computing their alleged AGIT

liabilities for the years at issue. Id. at 626. On June 3, 2016, the Court denied the

Department’s motion, finding a genuine issue of material fact, and granted the von

Erdmannsdorffs’ counter-motion. Id. The von Erdmannsdorffs’ appeal proceeded to

trial in October of 2016.      The Court heard oral argument on February 21, 2017.

Additional facts will be supplied as necessary.

                                 STANDARD OF REVIEW

       This Court reviews final determinations of the Department de novo. IND. CODE §

6-8.1-5-1(i) (2017). Accordingly, the Court is not bound by the evidence or the issues

presented to the Department at the administrative level. Horseshoe Hammond, LLC v.



                                              6
Indiana Dep’t of State Revenue, 865 N.E.2d 725, 727 (Ind. Tax Ct. 2007), review

denied.

                                         LAW

      Indiana imposes a tax at the rate of 3.4% on the adjusted gross income of

residents like the von Erdmannsdorffs.     See IND. CODE § 6-3-2-1(a) (2000).       The

Department, in turn, is charged with administering, collecting, and enforcing that tax.

See IND. CODE § 6-8.1-1-1 (2000) (amended 2002); IND. CODE § 6-8.1-3-1(a) (2000).

Accordingly, the Department may audit any returns filed and investigate any matters

relating to the AGIT. See IND. CODE § 6-8.1-3-12(a) (2000).

      When conducting an audit, the Department may “inspect any books, records, or

property of any taxpayer which is relevant to the determination of the taxpayer’s tax

liabilities[.]” IND. CODE § 6-8.1-4-2(a)(3) (2000). To that end, every person subject to

the AGIT “must keep books and records [(e.g., invoices, register tapes, receipts,

cancelled checks, or other source documents)] so that the [D]epartment can determine

the amount, if any, of the person’s [AGIT] liability . . . by reviewing those books and

records.”   IND. CODE § 6-8.1-5-4(a) (2000).   In addition, the person must allow the

Department to inspect his books and records at all reasonable times. I.C. § 6-8.1-5-

4(c). If the taxpayer fails to maintain or provide the Department with his books and

records, the Department may determine the taxpayer’s tax liability based on the best

information available to it. See I.C. § 6-8.1-5-4(a); IND. CODE § 6-8.1-5-1(a) (2000)

(amended 2006).

                                      ANALYSIS

      There is no dispute that the von Erdmannsdorffs did not keep books and records



                                           7
sufficient for the Department to determine their AGIT liabilities as required by Indiana

Code § 6-8.1-5-4(a). Moreover, there is no dispute that in light of the dearth of books

and records, the Department properly made the Proposed Assessments using the best

information available at that time. Because certain issues regarding the Department’s

Proposed Assessments were resolved during the summary judgment process, the

dispositive issue preserved for trial was whether the Department’s Proposed

Assessments based on the best information available were still valid in light of the von

Erdmannsdroffs’ evidence presented at trial.

                   I.    The von Erdmannsdorffs’ COGS Estimates

       The von Erdmannsdorffs claim that the Department should have adjusted the

Proposed Assessments to reflect their COGS estimates based on reconstructed

inventories that are “supported by fact and [] corroborated by third party insurance

records[,]” which demonstrates their superior reliability to the information used by the

Department.     (See Pet’rs’ Post-Tr. Br. (“Pet’rs’ Br.”) at 25-29.)          The Department

contends, however, that the von Erdmannsdorffs’ COGS estimates are unreliable

because their reconstructed inventories used flawed methodologies and are not

corroborated by the insurance records.4 (See Resp’t Redacted Post-Trial Br. (“Resp’t


4
   The Department has also claimed that the Court should not consider the von Erdmannsdorffs’
COGS estimates because doing so requires the Court to incorporate a federal tax law doctrine,
the Cohan Rule, into Indiana’s tax laws. (See Resp’t Redacted Post-Trial Br. (“Resp’t Br.”) at
16-18.) The Court, however, finds that it does not need to invoke the Cohan Rule to consider
the von Erdmannsdorffs’ evidence because, as explained during the summary judgment
proceedings, nothing within Indiana’s AGIT statutory scheme “expressly precludes taxpayers
from offering evidence [to the Court that was] generated post-audit” and the Court’s statutorily
prescribed de novo standard of review contemplates the introduction of such evidence. See
von Erdmannsdorff, 53 N.E.3d at 625. See also e.g., Edward Rose of Ind., LLC v. Metro. Bd. of
Zoning Appeals, Div. II, Indianapolis-Marion Cnty., 907 N.E.2d 598, 604 (Ind. Ct. App. 2009)
(defining “de novo judicial review” as the “‘nondeferential review of an administrative decision,
[usually] through a review of the administrative record plus any additional evidence the parties
present’” (citation omitted)).
                                               8
Br.”) at 11-16.)

                           A. The Reconstructed Inventories

       As mentioned, the von Erdmannsdorffs’ inventories for each of the years at issue

were reconstructed using several different methodologies. The Department claims that

these inventories are unreliable because they:         1) were not contemporaneously

prepared, 2) estimated the number of books, 3) estimated the cost of inventory, 4) used

straight-line adjustments, and 5) included property held for rent, not for sale. (See

Resp’t Br. at 10-16; Oral Arg. Tr. at 47-48, 51.)

                           1. Contemporaneous Preparation

       The   Department     contends    that the von     Erdmannsdorffs’    reconstructed

inventories were infirm because they were prepared at different times by different

individuals who relied on nothing more than “tape measure[s] and memories up to a

decade old.” (See Resp’t Br. at 4, 11-15.) Moreover, the Department asserts that the

reconstructed inventories are unreliable because the von Erdmannsdorffs completed an

inventory for the first time in June of 2010, nearly six-months after the close of the 2009

tax year, not contemporaneously at year-end as required by Treasury Regulation §

1.471-1. (See Oral Arg. Tr. at 42, 51; Resp’t Br. at 14-15.)

       During the years at issue, Indiana incorporated by reference certain provisions

of the Internal Revenue Code and its related regulations by defining adjusted gross

income under IRC § 62 as the starting point for calculating an individual’s Indiana

adjusted gross income. See IND. CODE § 6-3-1-3.5(a) (2000) (amended 2002). In turn,

Section 471 of the Internal Revenue Code provides the general rules for performing

inventories. See generally I.R.C. § 471 (2017); Treas. Reg. §§ 1.471-1 to -10 (2017)



                                             9
(collectively, the “Inventory Rules”).   The Inventory Rules provide that “[i]n order to

reflect taxable income correctly, inventories at the beginning and end of each taxable

year are necessary in every case in which the production, purchase, or sale of

merchandise is an income-producing factor.” Treas. Reg. § 1.471-1. Cases interpreting

the Inventory Rules, however, merely explain that their methodologies must conform as

nearly as possible to the customs and best accounting practices of a trade or business

and clearly reflect the income. See, e.g., Thor Power Tool Co. v. C.I.R., 439 U.S. 522,

531 (1979) (quoting Treas. Reg. § 1.471-2(a)(1); Van Pickerill & Sons, Inc. v. U.S., 445

F.2d 918, 920 (7th Cir. 1971). See also Wal-Mart Stores, Inc. & Subsidiaries v. C.I.R.,

153 F.3d 650, 656 (8th Cir. 1998) (explaining that the rule requiring year-end inventories

for books was repealed in 1922).

       The Department offered no evidence or legal authority to support its argument

that the von Erdmannsdorffs did not use a proper method to reconstruct their

inventories or that their failure to contemporaneously prepare their inventories

undermined their credibility. The von Erdmannsdorffs, on the other hand, offered expert

testimony by, Mr. Richard Bartholomew, an attorney and certified public accountant,

who is the Director of Tax Services at the Lafayette, Indiana accounting firm of Girardot,

Strauch & Company. (See Stip. ¶ 13, Ex. 9-J; Trial Tr. at 16-21.) Mr. Bartholomew both

advised Mr. von Erdmannsdorff on reconstructing inventories and prepared and filed Mr.

von Erdmannsdorff’s federal and state income tax returns for the years at issue. (See

Trial Tr. at 21-22, 36-37.)

       Mr. Bartholomew testified that when a ten-year assessment period is at issue,

the month that the reconstructed inventories are completed is of minimal importance



                                            10
because the beginning and ending inventory figures even out over the entire period.

(See Trial Tr. at 69.) Mr. Bartholomew further testified that the methodologies used to

reconstruct Von’s Shops’ inventories (e.g., physical counts, estimations, measurements,

and memories) were consistent with industry practices and clearly reflected Von’s

Shops’ income. (See Trial Tr. at 31-41, 52-56, 63-64; Trial Ex. 4-P.) Moreover, the trial

evidence established that the 2009 physical count inventory was completed at the end

of 2009, not in 2010 as the Department has alleged. (See Trial Tr. at 87-97; Stip. ¶

18(W), Confd’l Ex. 14-J(W) at 244; Sec. Stip. ¶¶ 8-9, Exs. 29-J ¶¶ 10-11, 30-J at 19-20

(demonstrating that the 2009 physical count inventory was actually completed in

December of 2009 and the inventory of books for 2009 was completed before July of

2010).) In light of this unrebutted evidence, the Department has not shown that the von

Erdmannsdorffs’ reconstructed inventories are unreliable on the basis that they were not

contemporaneously prepared.

                                2. The Inventory Of Books

      The Department also contends that the 2009 inventory of books lacks probative

value because it “was not an actual count [of books], but [rather] an estimate based on

the size of shelving.” (See Resp’t Br. at 15; Oral Arg. Tr. at 41-43.) Without providing

any evidence or legal authority as support, the Department asserts that the von

Erdmannsdorffs should have “count[ed] all the books[ because] that’s what other

bookstores do.” (Oral Arg. Tr. at 43.)

      Mr. Bartholomew, however, explained that the Department’s conception of the

physical count methodology is a misnomer because the method does allow estimates of

homogenous items, such as books, that are based on identifiable standards (e.g.,



                                           11
volume, size, inches). (See Trial Tr. at 32-33.) Mr. Bartholomew also testified that Mr.

von Erdmannsdorff’s grouping of the books, based on their size and genre, was

consistent with industry standards. (See Trial Tr. at 32-33, 60.) Consequently, the von

Erdmannsdorffs’ evidence refutes the Department’s claim that the inventory of their

books was not probative because it utilized an estimate, not an actual count.

                              3. Estimated Inventory Costs

       Next, the Department argues that the von Erdmannsdorffs’ reconstructed

inventories are not reliable because they “did not include any tracking of the [actual]

value of [the] inventory[,]” but instead used estimated costs. (See Resp’t Br. at 15; Oral

Arg. Tr. at 43-44.) This argument, however, is unavailing given that Mr. Bartholomew

testified that when it comes to reconstructing inventories over a ten-year period, the

average price of homogenous items “is normally the most reasonable” way to value the

items. (See Trial Tr. at 33-34, 60-61.) Consequently, the Department has not shown

that the reconstructed inventories are unreliable because they used an item’s estimated

cost rather than its actual cost.

                              4. Straight-line Adjustments

       The Department also claims that the reconstructed inventories are unreliable

because they incorporated straight-line adjustments.      (See Resp’t Br. at 15.)     The

Department explains that while the von Erdmannsdorff’s spent a “great deal of time and

energy highlighting the changes in their business and the market for their goods[,]” they

failed to capture those changes by using straight-line adjustments that treated the

“inventory [as if it] continued to grow or shrink at the same rate each and every year.”

(Resp’t Br. at 15.) The von Erdmannsdorffs’ unrebutted trial evidence refutes this claim



                                           12
as well.

       During the trial, Mr. von Erdmannsdorff and Mr. Bartholomew explained that the

reconstructed inventories used additional short-term adjustments to capture abnormal

changes in inventory, including the rapid disposition of the VHS and CD inventories and

the increased purchases of other items, such as used books, DVDs, and beads. (See

Trial Tr. at 44-46, 72-86, 95-96, 112-13; Stip. ¶¶ 19(A), 22(S), Exs. 15-J(A), 17-J(S).)

(See also Trial Tr. at 122-31.) Mr. von Erdmannsdorff also presented several articles

that not only detailed the gradual decline of VHS tapes and CDS in their respective

industries, but also substantiated his claim that his VHS tape and CD inventories

became obsolete during the years at issue. (See Stip. ¶¶ 22(K)-(L), 22(N)-(O), Exs. 17-

J(K)-(L), 17-J(N)-(O); Pet’rs’ Second Req. Judicial Notice, Exs. AA - PP.) (See also,

e.g., Trial Tr. at 43-44, 56.)   Moreover, the fact that Von’s Video and Comics closed in

2006 and moved the remaining VHS tapes and comic book inventory to Von’s Shops in

spaces once occupied by CDs, further substantiates Mr. von Erdmannsdorff’s claim

regarding the obsolescence of his VHS tape and CD inventories. (See, e.g., Trial Tr. at

75-86, 123-30; Stip. ¶¶ 22(B)-(D), Exs. 17-J(B)-(D).) Consequently, the Court finds the

Department failed to show that the reconstructed inventories’ use of straight-line

adjustments rendered them unreliable.

                                    5. Rental Property

       Finally, the Department claims that the reconstructed inventories are not reliable

because they improperly treated property held for rent (i.e., the VHS tapes and DVDs)

as if it were property held for resale. (See Resp’t Br. at 10.) The Department explains

that the VHS tapes and DVDs should have been depreciated as rental property, not



                                             13
included in COGS as if they were inventory.        (See Resp’t Br. at 10 (citing I.R.S.

Publication 946 at 5 (2010).) The Department’s claim is unpersuasive for two reasons.

       First, the unrebutted evidence established that Mr. von Erdmannsdorff sold VHS

tapes and DVDs during the years at issue and that their useful lives were, at times, less

than one year. (See Stip. ¶ 2; Trial Tr. at 83, 118, 129-30.) Second, although IRS

Publication 946 contains information regarding the treatment of inventory, the

Department did not show the Court how the Publication established that the von

Erdmannsdorffs erred when they included the VHS tapes and DVDs in their

reconstructed inventories. See I.R.S. Publication 946 at 5 (2010). Consequently, Mr.

von Erdmannsdorff could choose whether to recover the cost of the property by

expensing it, depreciating it, or including it in the COGS. See, e.g., Rev. Rul. 89-62,

1989-1 C.B. 78 (1989) (regarding expensing and depreciation); Retail Indus. Audit

Technique Guide, 2009 WL 9522670, at *49 (I.R.S. Feb. 2009) (regarding depreciation

and COGS).       Therefore, the Department has not shown that the reconstructed

inventories are unreliable on this basis either.

                               B. The Insurance Records

       During the trial, the von Erdmannsdorffs presented copies of insurance records

from a 2005 “fire loss and insurance claim” for Von’s Shops that valued its inventory at

$1,649,146 as of November 29, 2005. (See Sec. Stip. ¶ 2, Ex. 23-J.) The insurance

company arrived at that value by conducting an inventory of Von’s Shops based on an

actual count of its merchandise and cost information derived from its written invoices

and from Mr. von Erdmannsdorff. (See Trial Tr. at 97-99, 109, 132-34; Sec. Stip. ¶ 2,

Ex. 23-J at 539.)



                                             14
       The Department claims that the insurance records do not substantiate the von

Erdmannsdorffs’ reconstructed inventories because they “clearly state that they rely on

information provided by [the von Erdmannsdorffs], but no documentation has been

provided to this Court” to prove that the information is accurate. (See Resp’t Br. at 14;

Oral Arg. Tr. at 49-50.) The Department further claims that the insurance records

themselves are unreliable because the von Erdmannsdorffs and the insurance

company’s interests were “directly aligned[:]”

          The insurance company would have had a financial interest in
          minimizing [its] liability for damage, which would have been
          accomplished by understating the amount and value of the
          inventory owned by [the von Erdmannsdorffs]. Similarly, the [von
          Erdmannsdorffs] . . . have an interest in minimizing the amount of
          inventory on hand during the [years at issue], as this would reduce
          their taxable income and minimize any tax liability.

(Resp’t Br. at 14.)

       The von Erdmannsdorffs’ trial evidence, however, demonstrated the reliability of

the insurance company records as corroboration for their estimates. The trial evidence

showed that the insurance company conducted an independent, third-party count of

Von’s Shops’ actual inventory in processing the insurance claim. (See Trial Tr. at 97-

98, 132-34.)    Moreover, Mr. von Erdmannsdorff testified that although used book

vendors usually did not provide him with invoices, he did provide the insurance

company with used book invoices when he had them. (See Trial Tr. at 111-12.)

       The Department has provided nothing more than allegations that the insurance

company’s inventory is unreliable, presuming the Court will find this conclusion self-

evident. The Court does not find, however, that the insurance company’s inventory is

inherently unreliable simply because it used cost information based on written invoices



                                            15
and Mr. von Erdmannsdorffs’ estimates. Furthermore, the Department’s suggestion that

the insurance company’s records are not reliable because the von Erdmannsdorffs and

the insurance company’s interests were “directly aligned” is unavailing because it is a

bald allegation lacking evidentiary support.        See, e.g., Knox Cnty. Prop. Tax

Assessment Bd. of Appeals v. Grandview Care, Inc., 826 N.E.2d 177, 184-85 (Ind. Tax

Ct. 2005) (providing that when allegations are unsupported by factual evidence they

remain mere allegations).

      Here, the unrebutted evidence shows that the insurance company valued Von’s

Shops’ inventory at $1,649,146 as of November 29, 2005, and Mr. von Erdmannsdorff

valued Von’s Shops inventory at $1,770,552 as of December 31, 2005. (See Sec. Stip.

¶ 2, Ex. 23-J at 530, 539-43; Stip. ¶ 22(S), Ex. 17-J(S).) There is no indication that Mr.

von Erdmannsdorff relied on the insurance company’s records in arriving at his

valuation. (See Stip. ¶ 22(S), Ex. 17-J(S); Trial Tr. at 97-98; Sec. Stip. ¶ 2, Ex. 23-J at

530.) Indeed, the evidence shows that Mr. von Erdmannsdorff relied on the 2000 and

2009 Inventories to arrive at his valuation.     Consequently, the Court finds that the

insurance records do corroborate the von Erdmannsdorffs’ reconstructed inventories.

                      II.   The Department’s COGS Estimates

      As previously mentioned, the Department based its COGS estimates for all the

years at issue on the 2006 BizStats’ compilation of business data from the category

labeled “sole proprietorship sporting goods-hobby-book-music stores.”            The von

Erdmannsdorffs claim that the Department’s COGS estimates are not reliable because

they a) were derived from a BizStats category that is not comparable to Von’s Shops

and b) produced COG estimates that are inconsistent with several other undisputed



                                            16
facts. (See Pet’rs’ Br. at 12-25; Oral Arg. Tr. at 4-7.)

                                   A. The BizStats Category

       The Department asserts its COGS estimates are reliable because they were

based on the BizStats category that “accurately describes several of the industries in

which [Mr. von Erdmannsdorff’s] business was engaged,” given that he has admitted to

selling books, music, and several hobby items (e.g., beads, rocks, and guitar strings).

(See Resp’t Br. at 9-11 (citing Trial Tr. at 73, 114); Oral Arg. Tr. at 37-39.) Moreover,

there is no dispute that Von’s Shops rented VHS tapes and DVDs and sold comic

books, new/used books, music in vinyl and CD formats, beads, greeting cards, rocks,

VHS tapes, DVDs, guitar strings, and several other items. At first blush, therefore, the

name of the BizStats category itself, “sole proprietorship sporting goods-hobby-book-

music store,” suggests that it includes businesses like Von’s Shops. Its very name,

however, also suggests that it includes businesses dissimilar to Von’s Shops (i.e.,

sporting goods stores) and excludes others that are similar (i.e., video rental stores).

Consequently, additional details regarding the actual make-up of the businesses in the

BizStats category are needed to ascertain whether any of these facial differences may

have an impact on the reliability of the Department’s COGS estimates.          See, e.g.,

Peters v. Garoffolo, 32 N.E.3d 847, 853 (Ind. Tax Ct. 2015) (stating that to establish the

comparability of real property, the proponent of the evidence must explain the

characteristics of the subject property, how those characteristics relate to those of the

purportedly comparable properties, and how any differences between the properties

affected their relative values).

       During the trial, one of the Department’s witnesses explained that BizStats



                                             17
classifies businesses consistent with the six-digit North American Industry Classification

System (NAICS) code5 contained on taxpayers’ federal income tax returns. (See Trial

Tr. at 181.) While Mr. von Erdmannsdorff’s federal income tax returns contained two

different six-digit NAICS codes, his reporting does not indicate whether the

Department’s chosen BizStats category is consistent with his NAICS codes, nor does

his use of the NAICS codes shed light on the actual make-up of the BizStats category.

(See, e.g., Stip. ¶¶ 9, 18(B), 18(F), Ex. 3-J, Confd’l Exs. 14-J(B) at 103 (Line B), 14-J(F)

at 125 (Line B).)     Moreover, the Department did not provide any specific details

regarding the BizStats category businesses, such as the number of sporting goods

stores or music stores, the sizes of the stores, or the geographic locations of the stores.

(See, e.g., Trial Tr. at 167-69.)

       In contrast, the von Erdmannsdorffs’ evidence demonstrated that their COGS

estimates for Von’s Shops’ new books and music inventories were higher than the

BizStats sales financial ratio of 56.48%. (See Stip. ¶ 22(H)-(I), 22(K)-(L), Exs. 17-J(H)-

(I), 17-J(K)-(L), Trial Tr. at 101-102.) They also demonstrated that factors unique to the

video rental and music industries rendered Von’s Shops VHS and CD inventories

increasingly obsolete.       Thus, the von Erdmannsdorffs demonstrated that the

Department failed to account for factors that may have caused the COGS of businesses

in the BizStats category to vary from the BizStats figure of 56.48% that the Department

used for its COGS estimates.        (See Trial Tr. at 167-68.)   Given the totality of the

evidence, and the lack thereof, it is unreasonable to infer that the BizStats category the

5
  “The North American Industry Classification System (NAICS) is the standard used by Federal
statistical agencies in classifying business establishments for the purpose of collecting,
analyzing, and publishing statistical data related to the U.S. business economy.” North
American        Industry     Classification     System,       U.S.       CENSUS     BUREAU,
https://www.census.gov/eos/www/naics/index.html (last visited Sept. 5, 2017).
                                            18
Department used is comparable to the business profile of Von’s Shops. Therefore, the

Court finds that the Department’s use of the BizStats category for a sole proprietorship

sporting goods-hobby-book-music store detracts from the reliability of its COGS

estimates.

                                B. Other Inconsistencies

       The von Erdmannsdorffs also contend that the Department’s COGS estimates

are not accurate because they “produce[d] ending inventory increases, inventory

turnovers, and gross profit margins” that are inconsistent with the facts. (See Pet’rs’ Br.

at 18-19.) The Court will address these three claims in turn.

                            1. The Ending Inventory Increases

       The von Erdmannsdorffs first assert that the Department’s COGS estimates are

inaccurate because they showed that Von’s Shops’ ending inventory had continued to

increase each year during the ten-year assessment period. (See Pet’rs’ Br. at 19-23

(citing Trial Tr. at 48-51, Trial Ex. 3-P; Stip. ¶ 22(X), Confd’l Ex. 17-J(X) (indicating that

the Department’s ending inventory figures for the years at issue were 318% higher than

those of the von Erdmannsdorffs)).) The von Erdmannsdorffs maintain that inventory

increases were neither realistic nor plausible because their unrebutted evidence shows

they had reduced their existing inventory and purchased fewer new items during that

period in response to both the obsolescence of VHS tapes and CDs and the closure of

Von’s Video and Comics. (See Pet’rs’ Br. at 20-22.) (See also, e.g., Trial Tr. at 73-82,

122-30, 147-48; Stip. ¶¶ 22(G)-(L), Exs. 17-J(G)-(L).)

       The Department does not dispute that its COGS estimates indicate that Von’s

Shops’ inventory increased during each of the years at issue. (See generally Resp’t Br.;



                                             19
Oral Arg. Tr. at 30-54.)      Without directly addressing this argument, however, the

Department counters that its use of BizStats’ data was proper because when it used the

total sales and total purchases data that Mr. von Erdmannsdorff had provided during the

audit to determine Von’s Shops’ COGS, “the resulting calculations distorted [the von

Erdmannsdorffs’] income.” (See Resp’t Br. at 6 (citing Stip. ¶ 16, Confd’l Ex. 12-J at 67;

Trial Tr. at 164).) The Department’s response is unpersuasive for two reasons.

       First, while the Department’s argument suggests that its authority to use BizStats

and the manner in which it used the BizStats data are at issue, they are not. Rather,

the present issue simply concerns the accuracy of the Department’s COGS estimates

given the evidence introduced at trial. Second, the evidence on which the Department

has relied indicates that it believed that the use of total purchases would overstate

Von’s Shops’ COGS due to the amount of its obsolete inventory; it does not indicate,

however, that the Department actually performed any calculations to verify that belief.

(See Stip. ¶ 16, Confd’l Ex. 12-J at 67; Trial Tr. at 164.)

       The United States Tax Court has explained that

          [t]he cost of goods sold is determined by adding to opening
          inventory for the year the purchases (cost of goods acquired during
          that year) and subtracting from that sum the closing inventory
          (goods still on hand at the end of that year). Thus, any
          undervaluation of ending inventory for a taxable year increases the
          cost of goods sold, decreases the income from sales, and results in
          a lower profit for that year.

Primo Pants Co. v. C.I.R., 78 T.C. 705, 723 (T.C. 1982). Consequently, because the

ending inventories derived from the Department’s COGS estimates are not supported

by the evidence, it is more probable that the Department’s COGS estimates are too low

and that its calculations of the von Erdmannsdorffs’ taxable income for the years at



                                             20
issue are too high. Accordingly, on this basis, the von Erdmannsdorffs have shown that

the Department’s COGS estimates are less reliable than theirs.

                                 2. Inventory Turnovers

       The BizStats data states that inventory as a percentage of sales for a sole

proprietorship sporting goods-hobby-book-music store is 20.52%. (Stip., ¶ 9, Ex. 3-J.)

The von Erdmannsdorffs contend that “[t]his means that, on average, [the] businesses

[within this BizStats category] turned their inventory over nearly 5 times in 2006[,]” but

the Department’s COGS estimate only “produce[d] an inventory turnover [for Von’s

Shops] of once every 2.88 years.” (See Pet’rs’ Br. at 23-24; Pet’rs’ Post-Trial Reply Br.

at 2-3.) Moreover, the von Erdmannsdorffs’ evidence shows that “Von’s Shops barely

turned its inventory over once” during the 2006 tax year. (See Pet’rs’ Br. at 23-24 (citing

Trial Tr. at 49-51; Trial Ex. 3-P, Table 4; Stip. ¶ 22(X), Confd’l Ex. 17-J(X)).)

       The Department, on the other hand, maintains that the von Erdmannsdorffs are

wrong because:

          [i]nventory as a percent of sales is a distinct metric from inventory
          [turnovers]. Although the [von Erdmannsdorffs] attempt to imply
          that this figure means that inventory was flipped over 5 times, it can
          also indicate other phenomena. A lower figure for inventory as a
          percent of sales can indicate obsolescence, where some items in
          inventory are sold that were not replaced. This would lead to an
          increase in sales and a decrease in inventory.

(Resp’t Br. at 10.) The Department, however, has not supported this contention with

any binding authority, persuasive authority, or evidence. Therefore, the Court declines

to give any weight to the Department’s claim in this regard.

                                 3. Gross Profit Margins

       Finally, the von Erdmannsdorffs claim that its evidence demonstrates that Von’s



                                              21
Shops sold music and books at steep discounts and purchased other items at rates

exceeding the BizStats sales financial ratio of 56.48%; thus, its gross profit margins for

those items were substantially less than the BizStats gross profit margin of 43.52%

relied on by the Department. (See Pet’rs’ Br. at 24-25 (citing Stip. ¶¶ 9, 18(V), Ex.3-J,

Confd’l Ex. 14-J(V); Trial Tr. at 101-03, 105, 151).) In response, the Department merely

states that its COGS estimates are accurate because its audit figures are consistent

with certain census data. (See Resp’t Br. at 18-19.)

      The census data on which the Department relies concerns the same BizStats

category that the Court found detracts from the reliability of the Department’s COGS

estimates. Accordingly, the census data sheds no further light on the composition of the

BizStats category. See, e.g., Annual Retail Trade Survey Methodology, U.S. CENSUS

BUREAU, http://www.census.gov/retail/arts/how_surveys_are_collected.html (last visited

Sept. 5, 2017). Consequently, the census data does not rebut the von Erdmannsdorffs’

evidence concerning the gross profit margin inconsistencies. Therefore, the Court finds

that the Department’s COGS estimates unreliable on this basis as well.

                                     CONCLUSION

      For all the reasons stated above, the Court finds that the Departments Proposed

Assessments, while properly based on the best information available when originally

issued, should have been adjusted to reflect the more reliable evidence presented

during the administrative protest and the original tax appeal. Accordingly, the Court

finds in favor of the von Erdmannsdorffs and against the Department.




                                           22
