T.C. Memo. 1997-416
UNITED STATES TAX COURT
NICHOLAS A. AND MARJORIE E. PALEVEDA, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 840-96. Filed September 18, 1997.
Nicholas A. Paleveda, for petitioners.
Clinton M. Fried, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
WELLS, Judge: Respondent determined deficiencies in
petitioners' Federal income tax and additions to tax and
accuracy-related penalties for the taxable years 1990 and 1991 as
follows:
Additions Accuracy-Related
to Tax Penalties
Year Deficiency Sec. 6651(a)(1) Sec. 6662(a)
1990 $45,861 $11,465 $9,172
1991 47,688 11,922 9,538
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In the amended answer, respondent asserts revised deficiencies in
petitioners' Federal income tax and additions to tax and
accuracy-related penalties for the taxable years 1990 and 1991 as
follows:
Additions Accuracy-Related
to Tax Penalties
Year Deficiency Sec. 6651(a)(1) Sec. 6662(a)
1990 $92,568 $23,142 $18,514
1991 34,433 8,609 6,887
Unless otherwise indicated, all section and Code references
are to the Internal Revenue Code in effect for the years in
issue, and all Rule references are to the Tax Court Rules of
ractice and Procedure. After concessions,1 the issues to be
decided are as follows:2
1. Whether petitioners have substantiated their claimed
deductions on Schedule C for certain business expenses;
2. whether petitioners are entitled to certain passive
losses;
1
Petitioners conceded certain adjustments relating to
unreported interest income, an IRA distribution and a penalty
thereon, a self-employment health insurance deduction, and a
self-employment tax deduction. Additionally, at trial,
petitioners conceded the sec. 6651(a)(1) additions to tax. We
therefore do not consider those additions.
Respondent conceded that petitioners are entitled to
additional itemized deductions for real estate taxes in the
amount of $7,732, an interest expense in the amount of $15,968,
and charitable contributions in the amount of $7,715.
2
In their petition, petitioners disputed respondent's
disallowance of a Schedule A deduction for real estate taxes to
the extent of $6,106 for petitioners' 1990 taxable year.
Petitioners, however, make no argument on brief concerning that
issue. Consequently, we consider it to have been conceded.
Rybak v. Commissioner, 91 T.C. 524, 566 (1988).
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3. whether petitioners have substantiated their claimed
deductions on Schedule A for certain itemized expenses;
4. whether petitioners have failed to report income in the
amount of $159,282 for taxable year 1990 and whether petitioners
overreported income in the amount of $41,512 for taxable year
1991;
5. whether petitioners are entitled to a business bad debt
deduction for taxable year 1990 for the worthlessness of a loan;
and
6. whether petitioners are liable for accuracy-related
penalties pursuant to section 6662(a) for the taxable years in
issue.
FINDINGS OF FACT
Some of the facts have been stipulated for trial pursuant to
Rule 91. The parties' stipulations of fact are incorporated
herein by reference and are found as facts in the instant case.
At the time they filed their petition in the instant case,
petitioners resided in Atlanta, Georgia. Petitioners are husband
and wife.3
During the years in issue, petitioner Nicholas A. Paleveda
(petitioner) was an employee of Mutual Benefit Life Insurance Co.
(MBL). Petitioner received from MBL a Form W-2 for 1990 showing
wage income in the amount of $468,218.34 with Social Security tax
3
Petitioner Marjorie E. Paleveda signed the Federal income
tax returns for the taxable years in issue as Marjorie Ewing.
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withheld in the amount of $3,924.45. MBL has no record of
receiving from petitioner any communication disputing the
accuracy of the 1990 Form W-2 or assigning petitioner's wage
income. Petitioner is being sued by MBL for commission
chargebacks relating to petitioner's 1990 and 1991 wage income.
On May 29, 1986, Ben D. Razon (assignor) and the law firm of
Hampton, Paleveda, Murphy, Cody & Levy (assignee or firm)
executed an Agreement for Assignment of Partnership Interest
(agreement) in Med-Center, a Florida partnership, in
consideration of the firm's payment of $30,000. Petitioner
executed the agreement on behalf of the firm. Additionally,
petitioner wrote a check, dated June 2, 1986, from an account in
his name to Mr. Razon in the amount of $30,000. In the memo
section of the check was the notation "Partnership Interest". As
to the firm's purchase of the partnership interest in Med-Center,
no note was ever executed and no loan amortization schedule was
ever issued.
The preamble to the agreement stated that the firm "desires
to take an assignment of a partial interest in the partnership
share owned by BEN D. RAZON". Additionally, the agreement
provided in relevant part:
1. BEN D. RAZON * * * for and in consideration of the
payment of $30,000.00, receipt of which is hereby
acknowledged and the assuming by HAMPTON, PALEVEDA,
MURPHY, CODY & LEVY of its proportionate share of the
Partnership liabilities of the above referenced
Partnership * * * does hereby irrevocably assign,
transfer and set over to the Assignee a proportionate
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share of his right, title and interest in the above
referenced Partnership.
* * * * * *
3. Each of the parties hereto agrees to execute any
and all documents necessary or appropriate to transfer
their interests hereby conveyed or to be conveyed to
the Partnership interest in the property owned by the
Partnership or the Lease Agreement as it pertains to
the property if necessary.
Petitioners filed their Federal income tax returns (returns)
for taxable year 1990 on or about May 20, 1992, and for taxable
year 1991 on or about June 3, 1994.
Petitioners claimed Schedule C business expenses in the
amounts of $188,104 for taxable year 1990 and $171,182 for
taxable year 1991. Respondent disallowed business expenses to
the extent of $118,371 for taxable year 1990 and $144,187 for
taxable year 1991.
Petitioners claimed Schedule E losses in the amount of
$17,751 for taxable year 1990 and $12,686 for taxable year 1991.
Respondent disallowed losses to the extent of $15,966 for taxable
year 1990 and $12,686 for taxable year 1991.
On their return for taxable year 1991, petitioners claimed
Schedule A itemized deductions in the amount of $56,927.
Respondent disallowed deductions to the extent of $9,244.
Respondent has conceded that, before statutory limitations,
petitioners are entitled to additional deductions for real estate
taxes in the amount of $7,732, charitable contributions in the
amount of $7,715, and interest expense in the amount of $15,968.
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In the amended answer, respondent asserts that petitioners
underreported their gross income to the extent of $159,282 for
taxable year 1990 and overreported their gross income to the
extent of $41,512 for taxable year 1991. Additionally, during
the audit, petitioners claimed a bad debt deduction in the amount
of $30,000 that was not reflected on their Federal income tax
returns or the notice of deficiency.
Respondent determined that, on the basis of all of the
adjustments in the notice of deficiency, petitioners were liable
for additions to tax and penalties pursuant to sections
6651(a)(1) and 6662(a). In the amended answer, to reflect the
adjustments related to petitioners' underreporting and
overreporting of income, respondent increased the addition to tax
and penalty for 1990 and decreased the addition to tax and
penalty for 1991.
OPINION
The first issue to be decided is whether petitioners have
substantiated their claimed Schedule C business expenses that
respondent disallowed to the extent of $118,371 for taxable year
1990 and $144,187 for taxable year 1991. Petitioners argue that
they are entitled to the deductions, citing Cohan v.
Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930) (under certain
circumstances, when taxpayers establish that they incurred a
trade or business expense but do not substantiate the amount of
the expense, the Court may estimate the amount of the deductible
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expense). Petitioners argue that their business expenses are
established by the more than 1,000 canceled checks presented by
petitioner at the audit level and by the fact that the deductions
in issue were allowed by respondent in the 30-day letter.
Deductions are a matter of legislative grace, and
petitioners bear the burden of proving that they are entitled to
the deductions claimed except as to increased deficiencies. Rule
142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992);
New Colonial Ice Co. v. Helvering, 292 U.S. 435 (1934).
Taxpayers must keep sufficient records to establish the amount of
their deductions. See sec. 6001; Meneguzzo v. Commissioner, 43
T.C. 824, 831-832 (1965); sec. 1.6001-1(a), Income Tax Regs.
Moreover, a taxpayer who claims a deduction bears the burden of
substantiating the amount and purpose of the item claimed.
Hradesky v. Commissioner, 65 T.C. 87, 90 (1975), affd. per curiam
540 F.2d 821 (5th Cir. 1976); sec. 1.6001-1(a), Income Tax Regs.
In the instant case, petitioners provided no books, records,
or checks substantiating the disallowed business expenses. As to
the checks petitioner claims to have presented at the audit
level, we decide petitioners' tax liability on the evidence
produced at trial and not a previous record developed at the
administrative level. Greenberg's Express, Inc. v. Commissioner,
62 T.C. 324, 328 (1974), and case cited therein. Accordingly, on
the basis of the record in the instant case, we conclude that
petitioners have not carried their burden of substantiating the
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amount and purpose of the disallowed business expenses. As
petitioners have failed to establish at trial that they incurred
any Schedule C trade or business deductions beyond those allowed
by respondent, Cohan v. Commissioner, supra, is not applicable in
the instant case. Accordingly, we sustain respondent's
disallowance of those deductions.
The next issue to be decided is whether petitioners are
entitled to certain passive losses that respondent disallowed to
the extent of $15,966 for taxable year 1990 and $12,686 for
taxable year 1991. In the exhibits accompanying the notice of
deficiency, respondent listed petitioners' passive losses for the
taxable years in issue under the heading "PART I - RENTAL REAL
ESTATE WITH ACTIVE PARTICIPATION" and computed the extent to
which petitioners were entitled to the $25,000 offset pursuant to
section 469(i).4 During each of the taxable years in issue,
4
Sec. 469(i)(1) provides:
(1) In general.--In the case of any natural
person, subsection (a) shall not apply to that portion
of the passive activity loss or the deduction
equivalent (within the meaning of subsection (j)(5)) of
the passive activity credit for any taxable year which
is attributable to all rental real estate activities
with respect to which such individual actively
participated in such taxable year (and if any portion
of such loss or credit arose in another taxable year,
in such other taxable year).
Sec. 469(i)(2) provides:
(2) Dollar limitation.--The aggregate amount to
which paragraph (1) applies for any taxable year shall
(continued...)
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however, petitioners' modified adjusted gross income was greater
than $150,000, with the result that the $25,000 offset was phased
out.5
Petitioners argue that they meet the requirements of the
section 469 material participation test in that the rental
properties were petitioners' former homes rented out and
petitioner materially participated in their active management.
Additionally, petitioner contends that, pursuant to section
469(i), their passive losses should be exempted by the $25,000
offset (to the extent of the phaseout) for rental real estate
activities.
Respondent argues that the exception provided in section
469(c)(7) for certain taxpayers who materially participate in a
real property business does not apply to the years in issue. We
agree. Section 469(c)(2) provides the general rule that the term
"passive activity" includes any rental activity. Section
469(c)(4) provides that section 469(c)(2) is to be applied
without regard to whether or not the taxpayer materially
participates in the activity. For taxable years beginning after
4
(...continued)
not exceed $25,000.
5
Sec. 469(i)(3)(A) provides:
(A) In general.--In the case of any taxpayer, the
$25,000 amount under paragraph (2) shall be reduced
(but not below zero) by 50 percent of the amount by
which the adjusted gross income of the taxpayer for the
taxable year exceeds $100,000.
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December 31, 1993, section 469(c)(7) provides an exception to the
general rule in section 469(c)(2) for taxpayers meeting certain
conditions.6 The taxable years in issue in the instant case,
however, are 1990 and 1991. Accordingly, the section 469(c)(7)
exception does not apply in the instant case.
Respondent argues that, for purposes of the $25,000 offset
for rental real estate, petitioners have not established that
they "actively participated" in their rental real estate
activities as required by section 469(i). In the instant case,
however, respondent phased out the $25,000 offset because
petitioners' modified adjusted gross income exceeded $150,000 for
each of the taxable years in issue. As petitioners provide no
further arguments as to their passive losses, we sustain
respondent's determinations, to the extent that the $25,000
6
Sec. 469(c)(7) provides, for taxpayers meeting the
requirements of sec. 469(c)(7)(B), that
(A) In general.--If this paragraph applies to any
taxpayer for a taxable year --
(i) paragraph (2) shall not apply to any
rental real estate activity of such taxpayer
for such taxable year, and
(ii) this section shall be applied as if
each interest of the taxpayer in rental real
estate were a separate activity.
Notwithstanding clause (ii), a taxpayer may elect to treat
all interests in rental real estate as one activity.
Nothing in the preceding provisions of this subparagraph
shall be construed as affecting the determination of whether
the taxpayer materially participates with respect to any
interest in a limited partnership as a limited partner.
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offset is phased out once the Rule 155 computations that we order
below are made. Rule 142(a).
As stated in our findings of fact, after concessions and the
application of statutory limitations, the amount of disallowed
deductions in issue is $4,934. Respondent argues that
petitioners have not substantiated their deduction for real
estate taxes to the extent of $1,384 and their deduction for
charitable contributions to the extent of $3,548 ($2 mathematical
error). Petitioners argue that their deductions are established
by the canceled checks presented by petitioner at the audit
level. Additionally, petitioners argue that, as respondent
disallowed many of the checks at the audit level on the grounds
that petitioners could have received a personal benefit, it is
impossible for petitioners to prove that they did not receive
such a benefit.
In the instant case, petitioners provided no books, records,
or checks substantiating the disallowed deductions. As to the
checks petitioner claims to have presented at the audit level, we
decide petitioners' liability for income tax deficiencies on the
evidence produced at trial and not a previous record developed at
the administrative level. Greenberg's Express, Inc. v.
Commissioner, 62 T.C. 324 (1974). On the basis of the record in
the instant case, we conclude that petitioners have not carried
their burden of substantiating the amount and purpose of the
disallowed deductions. Accordingly, we sustain respondent's
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disallowance of Schedule A deductions to the extent of $4,934 for
petitioners' 1991 taxable year.
We next decide whether petitioners have failed to report
certain income for taxable year 1990 and whether petitioners have
overreported income for taxable year 1991.7 Respondent increased
by $159,282 petitioners' gross income for their 1990 taxable year
to coincide with the amount reported on petitioner's Form W-2
from MBL and decreased petitioners' gross income by $41,512 for
their 1991 taxable year.8 At trial, Peter J. Gelcius, the Agency
Finance Supervisor of MBL Life Assurance Co. (formerly MBL),
testified that, on the basis of his review of MBL's business
records, MBL made payments to petitioner in the amount of
$468,218.34 for 1990 and in the amount of $98,726.62 for 1991.
Additionally, Mr. Gelcius testified that the checks from MBL were
made out to petitioner and that, in petitioner's file at MBL,
there was no assignment of petitioner's income.
A copy of petitioner's Form W-2 from MBL was admitted in
evidence, solely for the purpose of establishing that petitioner
received a Form W-2 from MBL which stated that during 1990 MBL
paid wage income in the amount of $468,218.34 to petitioner.
Additionally, respondent introduced, solely for impeachment
7
Respondent raised this issue as a new matter in the amended
answer and, accordingly, bears the burden of proof. Rule 142(a).
8
Petitioners did not agree that they overreported income for
their 1991 taxable year.
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purposes, certain business records of MBL which stated that,
during 1990, MBL paid to petitioner wage income in the amount of
$468,218.34.
Petitioners contend that, during 1990, petitioner received
no wage income from MBL but did receive $308,936 from Stuart
Financial Planning Corp. (Stuart). Petitioners argue that, at
the audit, they established that MBL paid Stuart, which paid
$308,936 to petitioner. Additionally, petitioners argue that
they reported income that was deposited in petitioners' account
at NationsBank for their 1990 taxable year. Alternatively,
petitioners argue that petitioner merely collected income in the
role of agent and, therefore, is not required to include that
amount in gross income.
Respondent has shown that, during taxable years 1990 and
1991, petitioner received from MBL wage income in the amounts of
$468,218.34 and $98,726.62, respectively. Mr. Gelcius testified
that MBL made payments to petitioner in the amount of $468,218.34
for 1990 and in the amount of $98,726.62 for 1991. Mr. Gelcius'
testimony as to the payments made to petitioner during 1991 is
corroborated by the parties' stipulation that petitioner received
from MBL wages in the amount of $98,726. Additionally, at trial,
Mr. Gelcius' testimony was neither discredited nor contradicted
by petitioner.
Petitioners argue that MBL paid Stuart, which then paid
petitioner. At trial, however, petitioner did not present
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evidence that disputed Mr. Gelcius' testimony that MBL made
payments to petitioner. The only questions that petitioner asked
Mr. Gelcius concerning the issue were: (1) "Do you have any
knowledge of me actually physically receiving the check and
depositing it in my bank account?", to which he responded: "I
was not asked to check on that. But no, I don't. But I could
have, though", and (2) "So as far as you know, this check could
have gone to Angelo Scharelli [the agency manager for the MBL
division in south Florida], who in turn deposits [it] in a master
bank account?", to which Mr. Gelcius responded: "I have no
knowledge of where that check would have went out. All I know is
that it would have been sent to Nicholas A. Paleveda." Mr.
Gelcius' testimony was uncontroverted.
Petitioners argue that they established at the audit that
MBL paid Stuart, which then paid $308,936 to petitioner. We,
however, decide petitioners' liability for income tax
deficiencies on the evidence produced at trial and not a previous
record developed at the administrative level, Greenberg's
Express, Inc. v. Commissioner, supra, and petitioners did not
offer any documentary evidence establishing that MBL paid Stuart
and that Stuart paid petitioner. Additionally, petitioners did
not provide any account statements from NationsBank or other
documentary evidence to establish that petitioner received only
$308,936 in income during 1990. Finally, petitioners offered no
documentary evidence establishing that petitioner merely
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collected income in the role of agent.
On the basis of the record in the instant case, we conclude
that during 1990, petitioner received from MBL wage income in the
amount of $468,218.34. Respondent has conceded that petitioners
are entitled to a decrease in their gross income for 1991 to the
tent of $41,512.9 Accordingly, we sustain respondent's
determinations.
The next issue to be decided is whether petitioners are
entitled to a bad debt deduction pursuant to section 166(a)(1)
for the worthlessness of an alleged loan. Petitioners argue that
the $30,000 payment to Mr. Razon during 1986 was a loan that was
made in connection with petitioner's trade or business and that
became worthless during 1991. Respondent contends that
petitioners have not established that a debtor-creditor
relationship existed between petitioner and Mr. Razon.
Alternatively, respondent argues that, if a debtor-creditor
relationship existed, petitioners have not established that the
9
In their brief, petitioners argued that, for 1991, they are
entitled to decrease their gross income to the extent of $87,159,
which petitioners allege is an amount that was characterized by a
Florida State court as a loan by MBL to petitioner. Respondent,
noting the decrease in petitioners' income for 1991 to the extent
of $41,512, argues that the issue was not raised in the petition
or at trial. We agree. Generally, we do not consider new issues
raised for the first time on brief. Rollert Residuary Trust v.
Commissioner, 80 T.C. 619, 636 (1983), affd. on other issues 752
F.2d 1128 (6th Cir. 1985); Markwardt v. Commissioner, 64 T.C.
989, 997 (1975); Estate of Mandels v. Commissioner, 64 T.C. 61,
73 (1975). Accordingly, in the instant case, we will not address
the issue of excluding the alleged loan in the amount of $87,159
from gross income.
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debt became worthless during 1990.
Section 166(a)(1) provides, in general, for the deduction of
debts that become wholly worthless during a taxable year. The
bad debt deduction is limited to a bona fide debt; that is, a
debt that arises from a debtor-creditor relationship based upon a
valid and enforceable obligation to pay a fixed or determinable
sum of money. Sec. 1.166-1(c), Income Tax Regs. For purposes of
section 166, a contribution to capital is not considered a debt.
In re Uneco, Inc., 532 F.2d 1204, 1207 (8th Cir. 1976); Kean v.
Commissioner, 91 T.C. 575, 594 (1988); sec. 1.166-1(c), Income
Tax Regs.
Characterization of an advance as either a loan or a capital
contribution is a question of fact which must be answered by
reference to all of the evidence, with the burden on the taxpayer
to establish that the alleged loans were bona fide debts. Rule
142(a); Dixie Dairies Corp. v. Commissioner, 74 T.C. 476, 493
(1980); Yale Ave. Corp. v. Commissioner, 58 T.C. 1062, 1073-1074
(1972). Objective factors are to be considered, and the
taxpayer's subjective intent alone is not conclusive of the issue
of characterizing an advance as debt or equity. In re Uneco,
Inc., supra at 1209.
Deductions are a matter of legislative grace, and
petitioners bear the burden of proving that they are entitled to
the deductions claimed. Rule 142(a); INDOPCO, Inc. v.
Commissioner, 503 U.S. at 84; New Colonial Ice Co. v. Helvering,
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292 U.S. 435 (1934). Taxpayers are required to maintain records
that are sufficient to enable the Commissioner to determine their
correct tax liability. See sec. 6001; Meneguzzo v. Commissioner,
43 T.C. at 831-832; sec. 1.6001-1(a), Income Tax Regs. Moreover,
a taxpayer who claims a deduction bears the burden of
substantiating the amount and purpose of the item claimed.
Hradesky v. Commissioner, 65 T.C. at 90; sec. 1.6001-1(a), Income
Tax Regs.
On the basis of the record in the instant case, we conclude
that petitioner has not established that the $30,000 payment to
Mr. Razon was bona fide debt. Although petitioner testified that
he made a loan to Mr. Razon, petitioner's subjective intent alone
is not conclusive of the issue of characterizing an advance as
debt or equity. In re Uneco, Inc., supra. Petitioners provided
no documentary evidence corroborating the payment as a loan.
Several considerations support our conclusion that
petitioner's payment to Mr. Razon was not a bona fide debt.
Petitioner testified that he and Mr. Razon did not execute a note
or establish a loan amortization schedule. The agreement
provides that "BEN D. RAZON * * * does hereby irrevocably assign,
transfer and set over to * * * [petitioner] a proportionate share
of his right, title and interest in the above referenced
Partnership". Additionally, pursuant to the agreement, the
parties agreed "to execute any and all documents necessary or
appropriate to transfer their interests hereby conveyed or to be
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conveyed to the Partnership interest in the property." The check
written by petitioner to Mr. Razon includes in the memo section
the notation "Partnership Interest". Accordingly, the foregoing
considerations dissuade us from concluding that petitioner's
$30,000 payment was a loan as opposed to something else, e.g.,
the purchase of a partnership interest in Med-Center.
Consequently, we conclude that petitioners have not established
that the $30,000 payment to Mr. Razon constitutes a bona fide
debt that is deductible as a business bad debt. Petitioners have
not advanced any other theory upon which a deduction could be
premised. Accordingly, we hold that petitioners are not entitled
to a bad debt deduction in the amount of $30,000.
Lastly, we turn to the accuracy-related penalties determined
by respondent.10 In the notice of deficiency, respondent
determined that, on the basis of all of the adjustments in the
notice of deficiency, petitioners were liable for penalties
pursuant to section 6662(a) for taxable years 1990 and 1991. In
the amended answer, to reflect the adjustments related to
petitioners' underreporting and overreporting of income,
respondent increased the penalty for taxable year 1990 and
decreased the penalty for taxable year 1991. Accordingly, the
10
In their brief, petitioners argue that the sec. 6651(a)(1)
additions to tax should be reduced. At trial, however,
petitioners conceded the additions to tax. See supra note 1.
Accordingly, we do not consider petitioners' argument. In any
case, petitioners offered no evidence on the issue. Rule 142(a).
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increase in the penalty attributable to petitioners'
underreporting of income for 1990 is a new matter within the
meaning of Rule 142(a), for which respondent bears the burden of
proof. Respondent, however, made no argument on brief regarding
the increase. Consequently, we consider the increase in the
penalty attributable to petitioners' underreporting of income for
1990 to have been conceded by respondent. Rybak v. Commissioner,
91 T.C. 524, 566 (1988).
Section 6662(a) imposes a 20-percent penalty on the portion
of an underpayment of tax that is attributable to, inter alia,
(1) negligence or disregard of rules or regulations or (2) any
substantial understatement of income tax. The term "negligence"
includes any failure to make a reasonable attempt to comply with
the provisions of the Code, including failure to exercise due
care, failure to do what a reasonable person would do under the
circumstances, or failure to keep adequate books and records or
to substantiate items properly. Sec. 1.6662-3(b)(1), Income Tax
Regs. The term "disregard" includes any careless, reckless, or
intentional disregard of the Code or the temporary or final
regulations issued pursuant to the Code. Sec. 6662(c); sec.
1.6662-3(b)(2), Income Tax Regs. A substantial understatement of
tax is defined as the amount which exceeds the greater of 10
percent of the tax required to be shown on the return for the
taxable year or $5,000. Sec. 6662(d)(1)(A).
The accuracy-related penalty does not apply to any portion
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of an underpayment with respect to which it is shown that there
was a reasonable cause and that the taxpayer acted in good faith.
Sec. 6664(c)(1). The decision as to whether the taxpayer acted
with reasonable cause and in good faith depends upon all
pertinent facts and circumstances. Sec. 1.6664-4(b)(1), Income
Tax Regs. The most important factor is the extent of the
taxpayer's efforts to assess the proper tax liability. Id.
Circumstances that may indicate reasonable cause and good faith
include an honest misunderstanding of fact or law that is
reasonable in light of the experience, knowledge, and education
of the taxpayer. Id. Petitioners must establish error in
respondent's determination that they are liable for the penalty
provided pursuant to section 6662(a). Rule 142(a); Estate of
Monroe v. Commissioner, 104 T.C. 352, 366 (1995).
As to the penalties determined by respondent in the notice
of deficiency, petitioners contend that they are not liable
because, at the audit, they produced canceled checks in support
of their deductions. Additionally, petitioners argue that
respondent required evidence beyond petitioners' checks that, in
some cases, was impossible to produce. Finally, petitioners
contend that there was no negligence and that they acted in good
faith.
We conclude that petitioners have not established error in
respondent's determination that they are liable for the section
6662(a) penalty. The section 6662(a) penalty does not apply to
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any portion of an underpayment with respect to which it is shown
that there was a reasonable cause and that the taxpayer acted in
good faith. Sec. 6664(c)(1). We conclude that the presentation
of canceled checks by petitioners at the audit, standing alone,
does not establish that there was reasonable cause for the
portion of the underpayment or that petitioners acted in good
faith with respect to that portion. Additionally, petitioners'
mere allegation that, in the instant case, they were not
negligent and that they acted in good faith does not meet the
requirements of section 6664(c). Petitioners have provided no
other evidence upon which a finding of reasonable cause and good
faith could be premised. Accordingly, we sustain respondent's
determination of a section 6662(a) penalty as to the deficiency
which is calculated in the Rule 155 computations that we order
below.
We have considered all of petitioners' remaining arguments
and find them to be without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.