T.C. Memo. 2003-343
UNITED STATES TAX COURT
HERSCHEL H. AND ROBERTA S. HOOPENGARNER, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 7986-00, 9423-01. Filed December 17, 2003.
James G. LeBloch, for petitioners.
Thomas J. Fernandez and Edwin Herrera, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
VASQUEZ, Judge: Respondent determined deficiencies in,
additions to, and penalties on petitioners Herschel and Roberta
Hoopengarner’s (petitioners) income tax as follows:
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Accuracy-Related
Addition to Tax Penalty
Year Deficiency Sec. 6651(a)(1) Sec. 6662(a)
1994 $5,054 -0- $892
1995 8,413 $234 906
1996 7,828 -0- 870
1997 34,289 -0- 6,858
1998 14,354 -0- 2,871
1999 8,974 -0- 1,795
The issues for decision are: (1) Whether petitioners are
entitled to carry forward claimed net operating losses (NOLs) for
1994, 1995, 1996, 1997, 1998, and 1999; (2) whether petitioners
are entitled to deduct claimed Schedule C expenses for 1994 and
1995; (3) whether petitioners are liable for an addition to tax
pursuant to section 6651(a)(1)1 for 1995; and (4) whether
petitioners are liable for an accuracy-related penalty pursuant
to section 6662(a) for 1994, 1995, 1996, 1997, 1998, and 1999.
These issues arise primarily from facts surrounding claimed net
operating loss deductions that were allegedly generated when
numerous banks foreclosed on five properties that petitioners had
been developing for commercial use.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
1
Unless otherwise indicated, all Rule references are to
the Tax Court Rules of Practice and Procedure, and all section
references are to the Internal Revenue Code as in effect for the
years in issue. All amounts are rounded to the nearest dollar.
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incorporated herein by this reference. Petitioners were married
in 1955. At the time they filed the petition, petitioners
resided in Laguna Niguel, California.
A. Petitioners’ Work History
Petitioner-husband (petitioner) began work in the insurance
business in 1957 or 1958 for Penn Mutual Insurance Co. (Penn
Mutual). Except for 2 years with a different insurance company,
petitioner was continuously employed by Penn Mutual until 1979.
In or about 1960, petitioner opened a Penn Mutual agency in
Orange County, California. Petitioner trained agents, and the
agency grew to employ approximately 40-50 people. In 1979,
petitioner earned approximately $75,000. In 1979 or 1980,
petitioner sold the agency to focus on real estate development
activities.
Beginning in 1955, petitioner-wife was employed as a school
teacher. She retired from teaching when her husband’s commercial
real estate development activities became successful.
B. Petitioner’s Real Estate Development Activities
Petitioner entered into commercial real estate development
beginning in 1963 or 1964. Initially, petitioner was successful
with these activities. He sold his first building at a profit,
and he was able to secure tenants, including his employer Penn
Mutual, for the buildings.
In 1978, petitioners formed the H & H partnership with Grant
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B. and Victoria T. Hornbeak under California law. The main
purpose of the partnership was to acquire real property in
Irvine, California, and to construct and rent a building on the
site. Grant Hornbeak was the managing partner. Petitioners and
the Hornbeaks each owned a 50-percent interest in the partnership
and shared net profits and net losses equally. The agreement
stated:
The Managing Partner shall provide quarterly
financial statements of the partnership’s activities to
each partner. In addition, the Managing Partner shall
furnish each partner with a copy of the income tax
return filed by the partnership * * *.
* * * * * * *
All books, records and accounts of the partnership
shall be open to inspection by all partners * * *.
Petitioner brought an asset base to the partnership so that
the partnership could secure bank loans to construct the
buildings. The bank loans were secured with some of petitioner’s
personal assets. Grant Hornbeak provided services for, and day-
to-day management of, the partnership in return for monetary
compensation.
The only return filed for the partnership (on March 12,
1984) was for the taxable year ending September 30, 1982.
On September 30, 1982, the partners dissolved the
partnership. The partnership was unsuccessful due to
historically high interest rates of approximately 20 percent.
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C. K-Mart Property
On December 26, 1980, petitioners, Grant Hornbeak, and
others purchased real estate located in Las Vegas, Nevada, for
$605,000 to construct a K-Mart. On May 17, 1982, the property
was transferred to the H & H partnership. On August 10, 1982, a
portion of the property was sold for $239,000. Petitioner
testified that he did not recall whether the proceeds from the
sale were reinvested in the property for improvements. On
September 22, 1983, Grant Hornbeak transferred his interest in
the property to petitioner for $127,500.
Between 1982 and 1984, loans were taken against the property
in the amounts of $670,000, $5,800,000, and $995,000.
In 1985, the property was foreclosed upon. The foreclosure
proceeds totaled $6,606,398.
D. Indio Property
H & H Land Development Corp. purchased the Indio property,
located in Riverside County, California, for $1,590,000. The
purchase price was secured by three deeds of trust. On August 1,
1980, and March 3, 1981, H & H Land Development Corp. recorded
additional deeds of trust in the amounts of $1,227,912 and
$221,000, respectively.
On February 9, 1982, H & H Land Development Corp. sold a
portion of the property for $54,000.
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In 1983, the property was foreclosed upon. The foreclosure
proceeds totaled $2,063,113.
E. Cowan Avenue Property
The Cowan Avenue property, located in Irvine, California,
was initially owned by the H & H partnership. On October 19,
1978, petitioners and the Hornbeaks recorded a grant deed for a
purchase price of $676,000. On August 30, 1979, a deed of trust
was recorded securing a loan on the property in the amount of
$745,000. On September 3, 1981, a collateral assignment of
leases was recorded securing a debt in the amount of $2,850,000.
Also on September 3, 1981, a deed of trust with assignment of
rents was recorded to secure a debt of $942,500.
In 1982, the property was foreclosed upon. A trust deed of
sale was recorded in satisfaction of the debt for $450,000
consideration received.
F. Avenida Del Mar Property
On January 16, 1981, petitioner and Grant Hornbeak acquired
the Avenida Del Mar property in San Clemente, California, for a
purchase price of $540,000. Concurrently, a deed of trust was
recorded securing a loan of $375,000. On March 17, 1981,
petitioner and Grant Hornbeak obtained a loan of $600,000,
secured by a deed of trust on the property. Concurrently, a deed
of trust in full reconveyance by the Bank of San Clemente was
recorded, which related to the property. On May 18, 1982, a
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$550,000 loan was obtained, secured by a deed of trust on the
property.
On January 27, 1982, a notice of default was recorded
pertaining to the $375,000 loan. On June 17, 1982, a deed of
trust was recorded securing a note of $900,000.
In 1984, the property was foreclosed upon.
G. Business Center Drive Property
On April 27, 1976, the property located at Business Center
Drive, Irvine, California, was assigned to petitioner for $67,500
in consideration. On October 16, 1978, petitioner obtained a
loan in the amount of $675,000. On June 26, 1979, a deed of
trust was recorded, securing a loan in the amount of $100,000.
Allan Silverman, a business acquaintance of petitioner, took
out a loan of $493,250 and gave the funds to petitioner to repay
a different loan on the property. Allan Silverman’s loan was
partially secured by the Business Center Drive property. On
October 5, 1990, according to the schedule prepared by Revenue
Agent John Grennan regarding this property, petitioner
transferred a 50-percent interest in the property to Allan
Silverman. Petitioner collected the rents on the Irvine Business
Center property and kept the money for himself instead of paying
the bank or Allan Silverman on the loan.
In 1992, the property was foreclosed upon.
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H. Petitioners’ Financial Difficulties
Petitioners lost personal assets (totaling approximately
$2.5-$3 million), including their house, about the time when the
foreclosures upon the K-Mart, Indio, Cowan Avenue, and Avenida
Del Mar properties occurred. Petitioners’ cars were not
foreclosed upon. In 1988, petitioners moved to a rental house on
Balboa Island, California. Petitioners were unable to afford the
legal retainer fee to file for bankruptcy.
Petitioner-wife returned to teaching to supplement their
income, earning approximately $25,000 per year. Petitioner
returned to selling insurance. Petitioner earned approximately
$35,000-$50,000 in 1984-85, but his income increased to $75,000
by 1990.
I. Petitioners’ Tax Returns
Petitioners timely filed tax returns for all years in issue,
except taxable year 1995. For 1978 through 1999, respondent’s
records show that petitioners reported adjusted gross income as
follows:
Year1 Adjusted Gross Income
1978 $8,925
1979 -13,427
1980 -22,524
1981 -2,095
1982 -248,845
1983 None reported on return
1984 -151,306
1985 -240,661
1986 -106,772
1988 -0-
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1989 -0-
1990 -820,198
1991 -796,911
1992 -787,394
1993 -724,043
1994 -678,567
1995 -627,612
1996 -575,790
1997 -438,628
1998 -365,005
1999 -285,208
1
For 1987, the parties provided no information as
to whether or not a return was filed or as to the
amount of taxable income or adjusted gross income.
J. Respondent’s Adjustments
On May 15, 2000, respondent issued a timely notice of
deficiency for 1994, 1995, and 1996. On April 27, 2001,
respondent issued a timely notice of deficiency for 1997, 1998,
and 1999. Respondent made the following adjustments and
determinations:
NOL Schedule C
Carryover Expenses
Year Disallowed Disallowed Other Adjustments1
1994 $724,043 $9,950 -$298
1995 678,567 6,100 -431
1996 634,162 -0- -0-
1997 580,720 -0- -0-
1998 445,528 -0- 8,391
1999 364,635 -0- 1,909
1
The Other Adjustments include items such as “SE
AGI Adjustment”, “Social Security/RRB”, and “Itemized
Deductions.”
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OPINION
A. Petitioners Have Not Substantiated the Claimed NOLs
Petitioners have not substantiated their claimed net
operating losses.
Taxpayers are required to maintain adequate records to
substantiate claimed losses, and taxpayers bear the burden of
proving that they are entitled to claimed losses. Sec. 6001;
Rule 142(a);2 Welch v. Helvering, 290 U.S. 111, 115 (1933).
Petitioners, in deducting NOLs, bear the burden of
establishing both the existence of the NOLs and the amount of any
NOL that may be carried over to the subject years. United
States v. Olympic Radio & Television, Inc., 349 U.S. 232, 235
(1955); Keith v. Commissioner, 115 T.C. 605, 621 (2000); Jones v.
Commissioner, 25 T.C. 1100, 1104 (1956), revd. and remanded on
other grounds 259 F.2d 300 (5th Cir. 1958). Such a deduction is
a matter of legislative grace; it is not a matter of right.
United States v. Olympic Radio & Television, Inc., supra at 235;
Deputy v. Du Pont, 308 U.S. 488, 493 (1940).
Section 172 allows a taxpayer to deduct an NOL for a taxable
year. The amount of the NOL deduction equals the sum of the NOL
carryovers plus NOL carrybacks to that year. Sec. 172(a).
Absent an election to the contrary, an NOL for any taxable year
2
The parties agree that sec. 7491(a) is inapplicable in
this case, as the examination began before the effective date of
the statute.
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must first be carried back 3 years and then carried over 15
years.3 Sec. 172(b)(1)(A), (2), and (3). A taxpayer claiming an
NOL deduction for a taxable year must file with his return for
that year a concise statement setting forth the amount of the NOL
deduction claimed and all material and pertinent facts, including
a detailed schedule showing the computation of the NOL deduction.
Sec. 1.172-1(c), Income Tax Regs.
1. Petitioners’ Tax Returns Do Not Substantiate the
Claimed NOLs
A tax return is merely a statement of the taxpayer's claim
and does not establish the truth of the matters set forth
therein. Wilkinson v. Commissioner, 71 T.C. 633, 639 (1979).
Petitioner's 1994 through 1999 individual returns do not, by
themselves, substantiate the claimed NOLs. Furthermore,
petitioners did not provide the only tax return filed by the
partnership (for the taxable year ending in 1982), and
petitioners failed to provide their individual tax returns prior
to 1992, which are the years in which the net operating losses
were allegedly generated. Nor have petitioners provided the
Court with copies of tax returns filed by H & H Land Development
Corp. for any taxable year.
3
For 1998 and 1999, NOLs must be carried back 2 years and
then carried over 20 years.
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2. Petitioner’s Testimony Does Not Substantiate the
Claimed NOLs
Petitioner relies on his own testimony to substantiate the
claimed NOLs. We found petitioner’s testimony to be general,
vague, conclusory, and/or questionable in certain material
respects. Under the circumstances presented here, we are not
required to, and generally do not, rely on petitioner’s testimony
to sustain his burden of establishing error in respondent’s
determinations. See Lerch v. Commissioner, 877 F.2d 624, 631-632
(7th Cir. 1989), affg. T.C. Memo. 1987-295; Geiger v.
Commissioner, 440 F.2d 688, 689-690 (9th Cir. 1971), affg. per
curiam T.C. Memo. 1969-159; Tokarski v. Commissioner, 87 T.C. 74,
77 (1986).
Petitioner’s testimony was vague and unclear as to how the
loan proceeds contributed to improvements on the properties.
Indeed, petitioners did not object to respondent’s proposed
finding of fact which stated that petitioner “collected the rents
on the Irvine Business Center Property and kept the money for
himself instead of paying the bank on the loan.” Petitioner’s
testimony did not establish whether the loans incurred were
recourse or nonrecourse. Petitioners offered no testimony or
evidence as to depreciation claimed or deducted or “allowed and
allowable” on the properties.
Furthermore, petitioners offered no explanation regarding
how their adjusted gross income corresponded with losses incurred
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when the properties were foreclosed upon. For example, in 1989,
petitioners reported adjusted gross income of zero. In 1990,
petitioners reported adjusted gross income of -$820,198.
Petitioners contend that losses from foreclosures on the five
properties created the net operating losses. Based on the
stipulated facts in this case, however, four of the properties
were foreclosed upon between 1982 and 1985, and the fifth
property was not foreclosed upon until 1992. This is one of the
many inconsistencies evident in petitioners’ case.
Petitioners have failed to offer credible testimony to meet
their burden of substantiation in this case.
3. Petitioners Provided No Financial Records
Petitioners failed to provide any financial documentation to
substantiate the net operating losses. Petitioners did not
produce books or records for the alleged loss years to
substantiate the claimed losses. Petitioners provided no
financial statements from the H & H partnership. Petitioner
conceded that he does not have any records for the properties or
the H & H partnership, as his partner Mr. Hornbeak retained all
the records. Petitioner failed to obtain these records from Mr.
Hornbeak. Petitioners provided no financial statements from H &
H Land Development Corp. Petitioners provided no receipts as to
losses on the property. Petitioners provided no information as
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to costs incurred in buying or selling the properties, or in
foreclosure expenses.
Petitioners’ situation in this case is a result of their own
inexactitude and failure to maintain records of their expenses.
Further, we find petitioners’ efforts before trial to locate any
records that might be in the hands of third parties especially
lax.
4. Petitioners Failed To Call Key Witnesses
We note that neither Grant Hornbeak (petitioners’ partner in
the real estate transactions) nor anyone from Gendron & Co.
(petitioner’s accountant and preparer of the 1994 through 1999
tax returns) was called as witnesses. We infer that their
testimony would not have been favorable to petitioners. Wichita
Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946),
affd. 162 F.2d 513 (10th Cir. 1947).
5. The Court Will Not Estimate Petitioners’
Claimed NOLs
Despite the above mentioned discussion, petitioners argue
that they have substantiated their claimed net operating losses
for taxable years 1994 through 1999, based upon their alleged
bases in the properties and losses from the foreclosures.
Petitioners derived these numbers from property records gathered
by Revenue Agent Grennan during the audit. Petitioners argue
that at the time of foreclosure, they had bases and losses in the
properties as follows:
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Property Basis Loss
K-Mart $6,963,500 ($957,102)
Indio 2,930,912 (921,800)
Cowan Ave. 3,526,000 (226,000)
Business Center Dr. 371,251 (371,251)
Petitioners make no argument regarding basis or loss for the
Avenida Del Mar property.
If the taxpayer fails to keep adequate records but the Court
is convinced that deductible expenditures were incurred, the
Court may make as close an approximation as it can, bearing
heavily if it chooses upon the taxpayer whose inexactitude is of
his own making. Cohan v. Commissioner, 39 F.2d 540, 544 (2d Cir.
1930); Shea v. Commissioner, 112 T.C. 183, 187 (1999); see also
Sandoval v. Commissioner, T.C. Memo. 2000-189 (we may estimate
basis). However, there must exist some reasonable evidentiary
basis upon which to make such an estimate. Vanicek v.
Commissioner, 85 T.C. 731, 742-743 (1985); Edwards v.
Commissioner, T.C. Memo. 2002-169.
We are mindful that there must be sufficient evidence in the
record to provide a basis for us to make an estimate and to
conclude that a deductible expense was incurred in at least the
amount to be allowed. Pratt v. Commissioner, T.C. Memo.
2002-279. We are not required to guess with respect to the
amount of deductible expenses. Norgaard v. Commissioner, 939
F.2d 874, 879 (9th Cir. 1991), affg. in part and revg. in part
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T.C. Memo. 1989-390; Williams v. United States, 245 F.2d 559, 560
(5th Cir. 1957).
Petitioners have not shown a reasonable basis for concluding
that the loans taken against the properties should be included as
increases to basis. We are not convinced that the full amounts
of the loans were paid into the construction projects. Given the
circumstances of this case and the inexactitude apparent from
petitioners’ evidence, we have no reasonable evidentiary basis to
make an approximation as to the amount of net operating losses.
We could choose a raw percentage and apply that percentage to the
total amount of the loans. However, our choice of a percentage
would be mere guesswork with no reasonable evidentiary basis.
Petitioners dispute the computations and theory set forth by
Revenue Agent John Grennan. In analyzing whether petitioners had
substantiated their claimed NOLs, the Revenue Agent thought that
petitioners might have had cancellation of indebtedness income
when the foreclosures on the properties occurred. Due partially
to the possibility of cancellation of indebtedness income, the
net operating losses were not substantiated.
Petitioners argue that they did not have cancellation of
indebtedness income because they were insolvent when the
foreclosures occurred. Furthermore, since they did not have
cancellation of indebtedness income, petitioners argue that they
had net operating losses. While the Court is sympathetic to
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petitioners’ financial hardships, and assuming arguendo that
petitioners did establish basis using the public property
records, and did establish that they were insolvent,4 petitioners
are incorrect as a matter of law in stating that they had net
operating losses. Federal law provides that, generally, a
taxpayer must recognize income from the discharge of
indebtedness. Sec. 61(a)(12); United States v. Kirby Lumber Co.,
284 U.S. 1 (1931). The Code provides an exception to the
recognition of cancellation of indebtedness income in cases where
the discharge occurs when the taxpayer is insolvent. See sec.
108(a)(1)(B); see also Babin v. Commissioner, 23 F.3d 1032, 1035
(6th Cir. 1994), affg. T.C. Memo. 1992-673. Section 108(b)(1)
provides in turn that, upon discharge, the taxpayer must reduce
certain tax attributes by the amount of the cancellation of
indebtedness income excluded from gross income. Section
108(b)(2) provides that NOLs are the first tax attribute to be
reduced,5 and section 108(b)(3) provides that they be reduced
dollar-for-dollar by the amount of the cancellation of
indebtedness income excluded under section 108(a). Petitioners
have not proven that they did not have cancellation of
4
The Court makes no such findings.
5
A taxpayer can elect to reduce the basis of any
depreciable property by the amount of debt discharged before
reducing the amount of any other tax attributes. Sec. 108(b)(5).
Petitioners did not make such an election.
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indebtedness income at the time of the foreclosures. Nor have
they proven that any of the claimed NOLs were not reduced by
section 108(b)(1) and (b)(2).
For the aforementioned reasons, petitioners did not
substantiate their claimed net operating losses for the taxable
years 1994, 1995, 1996, 1997, 1998, and 1999.
B. Petitioners Failed To Address Claimed Schedule C Expenses
Petitioners reported income and expense for Insurance
Service on Schedule C of the 1994 and 1995 tax returns.
Respondent disallowed certain Schedule C expenses. Petitioners’
briefs fail to address this issue. We conclude that petitioners
have conceded the uncontested items and abandoned this issue.
See Petzoldt v. Commissioner, 92 T.C. 661, 683 (1989); Money v.
Commissioner, 89 T.C. 46, 48 (1987).
C. Late-Filed Return for 1995
Respondent determined that petitioners are liable for an
addition to tax pursuant to section 6651(a)(1) for 1995. Section
6651(a)(1) imposes an addition to tax for failure to file a
return on the date prescribed (determined with regard to any
extension of time for filing), unless the taxpayer can establish
that such failure is due to reasonable cause and not due to
willful neglect. The taxpayer has the burden of proving the
addition is improper. See Rule 142(a); United States v. Boyle,
469 U.S. 241, 245 (1985).
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Petitioners stipulated that they did not file their tax
return for 1995 until October 21, 1996, the day on which
respondent received the return. Petitioners offered no evidence
showing that the failure to file was due to reasonable cause and
not due to willful neglect. Accordingly, we hold that
petitioners are liable for the addition to tax pursuant to
section 6651(a)(1).
D. Section 6662 Accuracy-Related Penalty
Section 6662 provides for an accuracy-related penalty equal
to 20 percent of the underpayment if the underpayment was due to
a taxpayer’s negligence or disregard of rules or regulations.
See sec. 6662(a) and (b)(1). A taxpayer is negligent when he or
she fails “‘to do what a reasonable and ordinarily prudent person
would do under the circumstances.’” Korshin v. Commissioner, 91
F.3d 670, 672 (4th Cir. 1996) (quoting Schrum v. Commissioner, 33
F.3d 426, 437 (4th Cir. 1994), affg. in part, vacating and
remanding in part T.C. Memo. 1993-124), affg. T.C. Memo. 1995-46.
As pertinent here, “negligence” includes the failure to make
a reasonable attempt to comply with the provisions of the
Internal Revenue Code and also includes any failure to keep
adequate books and records or to substantiate items properly.
See sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs. A
taxpayer may, however, avoid the application of the accuracy-
related penalty by proving that he or she acted with reasonable
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cause and in good faith. See sec. 6664(c). Whether a taxpayer
acted with reasonable cause and in good faith is measured by
examining the relevant facts and circumstances, and most
importantly, the extent to which he or she attempted to assess
the proper tax liability. See Neely v. Commissioner, 85 T.C. 934
(1985); Stubblefield v. Commissioner, T.C. Memo. 1996-537; sec.
1.6664-4(b)(1), Income Tax Regs.
Petitioners argue that they provided all relevant
information to their tax return preparer, Gendron & Co.
Petitioners, however, have provided no testimony concerning the
information they gave to their return preparer. No employee from
Gendron & Co. testified at trial. Additionally, we have found
that petitioner failed to maintain adequate records related to
the claimed net operating losses. Therefore, we find the
underpayment attributable to negligence or disregard of rules or
regulations.
We conclude that petitioners are liable for a penalty
pursuant to section 6662 for 1994, 1995, 1996, 1997, 1998, and
1999.
In reaching all of our holdings herein, we have considered
all arguments made by the parties, and to the extent not
mentioned above, we find them to be irrelevant or without merit.
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To reflect the foregoing,
Decisions will be entered
for respondent.