T.C. Memo. 2004-276
UNITED STATES TAX COURT
JAMES G. AND LINDA C. JAROFF, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 19193-99. Filed December 8, 2004.
Steven D. Morford, for petitioners.
Nhi T. Luu-Sanders, for respondent.
MEMORANDUM OPINION
WOLFE, Special Trial Judge: This case was assigned pursuant
to the provisions of section 7443A(b)(5) in effect when these
proceedings commenced, and Rules 180, 181, and 183. Unless
otherwise indicated, all section references are to the Internal
Revenue Code in effect at relevant times, and all Rule references
are to the Tax Court Rules of Practice and Procedure.
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By notice of deficiency, respondent determined deficiencies
in petitioners’ Federal income tax, additions to tax under
section 6651(a), and accuracy-related penalties under section
6662 as follows:
Additions to Tax/Penalties
Sec. Sec. Sec. Sec. Sec.
Year Deficiency 6651(a) 6662(h) 6662(e) 6662(d) 6662(c)
1994 $15,535 $2,264 $6,214 $3,107 $3,107 $3,107
1995 8,837 507 3,415 1,707 1,707 1,707
Petitioners have conceded that they are liable for
deficiencies of $15,535 for 1994 and $8,837 for 1995. The
remaining issues for decision are: (1) Whether petitioners are
liable for additions to tax under section 6651(a) for filing
their income tax returns after the due dates and (2) whether
petitioners are liable for accuracy-related penalties under
section 6662.
Background
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference. Other facts are
established by admission. Neither petitioners nor any witnesses
testified on petitioners’ behalf. When they filed their
petition, petitioners resided in Scottsdale, Arizona.
Petitioner James Jaroff was employed as a computer
programmer for the Software Works! of L.A. and Allied Packaging
Corp. in 1994 and for Allied Packaging Corp. in 1995. Petitioner
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Linda Jaroff worked as a sales representative for the Software
Works! of L.A. and Allied Packaging Corp. in 1994 and for Allied
Packaging Corp. in 1995. Petitioners filed joint Federal income
tax returns for 1994 and 1995 and reported combined wages of
$98,078 for 1994 and $85,583 for 1995.
A. Petitioners’ 1994 and 1995 Income Tax Returns
The notice of deficiency in this case relates to losses
petitioners reported from their investment in the cattle breeding
operations of W.J. Hoyt Sons Ranches MLP, an entity operated by
Walter J. Hoyt III (Mr. Hoyt) (collectively referred to as the
Hoyt cattle operation).
In October 1995, petitioners purportedly purchased cattle
from the Hoyt cattle operation in exchange for a promissory note.
While the sales documents and other substantive details of the
transaction are not part of the record in this case,
correspondence between petitioners and members of the Hoyt cattle
operation indicate that the investment was intended to generate
significant operating losses that petitioners would use to reduce
or eliminate their income tax liability. Petitioners were
required to remit 75 percent of the tax refunds resulting from
the transaction to the Hoyt cattle operation, allegedly in
repayment of interest on the promissory note. As part of their
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investment, petitioners’ income tax returns were prepared by
Laguna Tax Service, an entity operated by Mr. Hoyt.1
Although they were not associated with the Hoyt cattle
operation until October 1995, petitioners reported losses from
their cattle investment on their 1994 income tax return, filed on
October 20, 1995. Petitioners attached to their 1994 income tax
return a Schedule F, Profit or Loss From Farming, and reported a
net loss of $184,000 from the “breeding value of registured [sic]
cattle”. The $184,000 net loss reflected gross income of
$191,636 less total expenses of $375,636. Expenses included
$165,625 in depreciation and section 179 expenses, $5,541 in
interest paid, $153,308 in “1994 Sharecrop Board expenses”, and
$51,162 in “Expense for the Cost Basis of Purchased Cattle that
Died in 1994". The $184,000 loss offset the $103,417 in adjusted
gross income petitioners earned in 1994 and resulted in
petitioners’ claiming a refund of tax withheld from their
earnings from employment in 1994 in the amount of $6,856. The
unused 1994 net operating losses were carried back to taxable
years 1991, 1992, and 1993.2
1
Mr. Hoyt was an enrolled agent registered to practice
before the Internal Revenue Service. After their 1994 return was
selected for examination, petitioners gave a power of attorney to
Mr. Hoyt to represent them before the Internal Revenue Service.
2
Petitioners’ taxes for 1991, 1992, and 1993 are not at
issue in this case.
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Petitioners attached to their 1995 income tax return, as
filed on October 18, 1996, a Schedule F and reported a net loss
of $46,395 from the Hoyt cattle operation. The loss reflected
gross income of $87,486 less total expenses of $133,881.
Expenses included $46,395 in depreciation and section 179
expenses and $87,486 in “1994 Sharecrop Bd Expenses”. In
addition, petitioners reported a net $3 loss from the sale of
breeding cattle on a Form 4797, Sales of Business Property,
reflecting a gross sale price for the cattle of $178,500 less a
cost basis of $317,733 (less $139,230 in depreciation).
Petitioners used the $46,395 in losses to offset in part the
$88,161 in adjusted gross income they reported in 1995, and
therefore they claimed a refund of $6,508 that was withheld from
their earnings from employment during the year.
Petitioners’ 1994 and 1995 income tax returns were filed
after they received extensions of the filing due dates. For
1994, petitioners filed a Form 4868, Application for Automatic
Extension of Time to File U.S. Individual Income Tax Return, and
received an automatic 4-month extension from the April 15 filing
date. On August 17, 1995, petitioners submitted a Form 2688,
Application for Additional Extension of Time to File U.S.
Individual Income Tax Return, and received an extended filing
date of October 16, 1995. Petitioners filed their 1994 return on
October 20, 1995.
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For 1995, petitioners also filed for the automatic 4-month
extension on Form 4868 and submitted a Form 2688 and received an
extended filing date of October 15, 1996. Petitioners’ 1995
return was filed on October 18, 1996.
B. Respondent’s Request for Admissions
On February 24, 2003, respondent served on petitioners’
counsel, Steven Morford (Mr. Morford), a copy of respondent’s
request for admissions (request). The request was filed with the
Court on February 25, 2003. Neither petitioners nor their
counsel responded to the request, and pursuant to Rule 90(c),
each matter set forth in the request was automatically deemed
admitted 30 days after the date of service. See also Morrison v.
Commissioner, 81 T.C. 644, 647 (1983); Freedson v. Commissioner,
65 T.C. 333, 334-36 (1975), affd. on other grounds 565 F.2d 954
(5th Cir. 1978).
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As a result, the following items are deemed admitted as
material facts:3
(1) Petitioners did not receive $191,636 in Schedule F
income for tax year 1994;
(2) petitioners did not receive $87,486 in Schedule F
income for tax year 1995;
(3) petitioners did not incur $165,625 in Schedule F
depreciation expenses for tax year 1994;
(4) petitioners did not incur $46,395 in Schedule F
depreciation expenses for tax year 1995;
(5) petitioners did not incur $5,541 in Schedule F interest
expenses in 1994;
(6) petitioners did not incur $153,308 in Schedule F
Sharecrop Board expenses for tax year 1994;
(7) petitioners did not incur $87,486 in Schedule F
Sharecrop Board expenses for tax year 1995;
(8) petitioners did not incur $51,162 in Schedule F
3
Petitioners’ counsel, Mr. Morford, made an oral motion to
modify the deemed admissions under Rule 90(f). The Court denied
the motion upon a showing by respondent that the request for
admissions was properly served at Mr. Morford’s business address
and that the merits of the trial would not be subserved by
modification of the deemed admissions. Respondent’s oral motion
that the admissions resulting from petitioners’ failure to
respond to the request for admissions, dated Feb. 24, 2003, be
made absolute was granted orally and by written order, and those
admissions are deemed admitted.
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“Expense for the Cost Basis of Purchased Cattle that Died in
1994" for tax year 1994;
(9) petitioners did not incur the $3 “Other Loss” as
claimed on Form 4797 for tax year 1995;
(10) petitioners did not make a bona fide and reasonable
estimate of their tax liabilities for inclusion with their
application for extension of time within which to file their 1994
Form 1040, U.S. Individual Income Tax Return;
(11) petitioners did not make a bona fide and reasonable
attempt to secure the information necessary to make an estimate
of their tax liabilities for inclusion with their application for
extension of time within which to file their 1994 Form 1040;
(12) petitioners did not remit a proper amount of estimated
tax with their application for extension of time within which to
file their 1994 Form 1040;
(13) petitioners did not make a bona fide and reasonable
estimate of their tax liabilities for inclusion with their
application for extension of time within which to file their 1995
Form 1040;
(14) petitioners did not make a bona fide and reasonable
attempt to secure the information necessary to make an estimate
of their tax liabilities for inclusion with their application for
extension of time within which to file their 1995 Form 1040;
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(15) petitioners did not remit a proper amount of estimated
tax with their application for extension of time within which to
file their 1995 Form 1040;
(16) petitioners did not sign sales documents or otherwise
become associated with the Hoyt cattle operation until October
1995; and
(17) petitioners were not associated with, nor did they
participate in, the Hoyt cattle operation in any fashion during
the tax year 1994.
Items (1)-(9) and (16)-(17) of the request were also
stipulated as facts by the parties. As a consequence of the
deemed admissions and the stipulation of facts, petitioners
conceded that they are liable for the deficiencies set forth in
their notice of determination.
C. Petitioners’ Failure To Appear at Trial and Concession of
Their Tax Liability for 1994 and 1995
Petitioners chose not to attend their trial and did not
provide any testimony. Petitioners’ counsel, Mr. Morford,
entered an appearance on their behalf. Mr. Morford explained
that petitioners probably had gone to work instead of appearing
for trial. Mr. Morford conceded petitioners’ liability for tax
deficiencies of $15,535 for 1994 and $8,837 for 1995 but disputed
petitioners’ liability for additions to tax and accuracy-related
penalties.
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Discussion
This case is part of a larger group of cases involving
cattle and sheep breeding partnerships organized by Mr. Hoyt.
For a description of the Hoyt organization and its operation, see
e.g., Barnes v. Commissioner, T.C. Memo. 2004-266; River City
Ranches #1, Ltd. v. Commissioner, T.C. Memo. 2003-150; Mekulsia
v. Commissioner, T.C. Memo. 2003-138, affd. __ F.3d __ (6th Cir.
Nov. 18, 2004); River City Ranches #4, J.V. v. Commissioner, T.C.
Memo. 1999-209, affd. 23 Fed. Appx. 744 (9th Cir. 2001); Mitchell
v. Commissioner, T.C. Memo. 1995-411.
The Commissioner’s determinations in a notice of deficiency
are generally presumed correct, and the taxpayer must prove those
determinations wrong in order to prevail. Rule 142(a); Welch v.
Helvering, 290 U.S. 111, 115 (1933).4 In this case, in which the
correctness of respondent’s determinations of tax has been
conceded, the burden is on petitioners to show that the additions
to tax and accuracy-related penalties should not apply.
Petitioners did not appear at trial and did not testify as
to facts underlying their investment in the Hoyt cattle operation
4
Sec. 7491, which under some circumstances shifts the
burden of proof or production to the Commissioner, is
inapplicable in this case. Sec. 7491 applies only to court
proceedings arising in connection with examinations commencing
after July 22, 1998. Internal Revenue Service Restructuring and
Reform Act of 1998, Pub. L. 105-206, sec. 3001(c), 112 Stat. 727.
Respondent’s examination of petitioners’ 1994 return began before
Aug. 16, 1996, and their 1995 return was examined before Feb. 24,
1997.
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and the losses reported on their income tax returns. Certain
facts and circumstances relevant in determining the applicability
of the additions to tax and accuracy-related penalties were known
solely to petitioners. Petitioners’ failure to introduce
evidence solely in their possession or peculiarly within their
knowledge creates a negative inference that the evidence, if
introduced, would be unfavorable to them. See Streber v.
Commissioner, 138 F.3d 216, 221-222 (5th Cir. 1998), revg. T.C.
Memo. 1995-601; Shaw v. Commissioner, 27 T.C. 561, 573 (1956),
affd. 252 F.2d 681 (6th Cir. 1958). While we have given careful
consideration to the arguments presented by petitioners’ counsel,
we cannot overlook the evidentiary gaps created by petitioners’
decision not to attend and provide testimony at their trial.
A. Addition to Tax Under Section 6651(a)(1)
Section 6651(a)(1) imposes an addition to tax for a
taxpayer’s failure to file a required return on or before the
specified filing date, which is determined with consideration of
any extension of time for filing. The amount of the liability is
based upon a percentage of the tax required to be shown on the
return. Sec. 6651(a)(1). The addition to tax is inapplicable,
however, if the taxpayer’s failure to file the return was due to
“reasonable cause and not due to willful neglect”. Id.
Generally, income tax returns made on the basis of the
calendar year must be filed on or before the 15th day of April
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following the close of the calendar year. Sec. 6072(a). An
individual taxpayer may receive an automatic 4-month extension by
filing a Form 4868 on or before the due date. Sec. 1.6081-
4(a)(2), Income Tax Regs. (applicable to taxable year 1994); sec.
1.6081-4T(a)(2)(i), Temporary Income Tax Regs., 61 Fed. Reg. 261
(Jan. 4, 1996) (applicable to taxable year 1995). If a taxpayer
requires an additional extension of time to file, he or she may
make such a request by filing a Form 2688. Secs. 1.6081-1(a) and
(b)(5), 1.6081-4(a)(5), Income Tax Regs.; sec. 1.6081-4T(a)(5),
Temporary Income Tax Regs., supra.
For the automatic 4-month extension to be effective, the
application on Form 4868 “must show the full amount properly
estimated as tax for the taxable year”. Sec. 1.6081-4(a), Income
Tax Regs.; sec. 1.6081-4T(a)(4), Temporary Income Tax Regs.,
supra. In addition, for taxable year 1994, the taxpayer is
required to remit the estimated tax when filing the Form 4868.
Sec. 1.6081-4(a), Income Tax Regs. To properly estimate his or
her tax liability, a taxpayer must make a bona fide and
reasonable attempt to locate, gather, and consult information
that will enable him or her to make a proper estimate of his or
her tax liability. See Crocker v. Commissioner, 92 T.C. 899,
908-910 (1989).
Petitioners are deemed to have admitted, through items (10)-
(15) of the request, the following: (1) They did not make bona
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fide and reasonable estimates of their tax liabilities for
inclusion with their applications for extensions of time to file
their 1994 and 1995 income tax returns, (2) they did not make a
bona fide and reasonable attempt to secure the information
necessary to make estimates of their tax liabilities for
inclusion with their applications for extensions of time to file
their 1994 and 1995 income tax returns, and (3) they did not
remit the proper amounts of estimated tax with their applications
for extensions of time to file their 1994 and 1995 income tax
returns. The record shows, by petitioners’ explicit admissions,
that petitioners’ Forms 4868 for 1994 and 1995 were invalid, and
consequently, we sustain respondent’s determinations that their
1994 and 1995 returns were untimely filed.
Petitioners are liable for additions to tax under section
6651(a)(1) unless they can show that their failure to file timely
income tax returns was due to reasonable cause and not willful
neglect. Petitioners did not appear at trial to testify on the
factual question whether their failure to file timely income tax
returns was due to reasonable cause and not willful neglect. In
reviewing the record, we find nothing to indicate that
petitioners exercised ordinary business care and prudence in an
effort to file their income tax returns on time. Because
petitioners had the burden to prove that their failure to file
was due to reasonable cause, and because of the admissions, the
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available evidence, and petitioners’ refusal to testify, the
record in this case clearly shows that petitioners’ failure to
file their income tax returns on time was not due to reasonable
cause.
Respondent’s determinations that petitioners are liable for
additions to tax for 1994 and 1995 are sustained.
B. Accuracy-Related Penalties
Section 6662(a) provides that a taxpayer may be liable for a
penalty of 20 percent of the portion of an underpayment of tax
attributable to (1) a substantial understatement of tax, (2)
negligence or disregard of rules or regulations, or (3) any
substantial valuation misstatement. Sec. 6662(a) and (b)(1),
(2), and (3). The accuracy-related penalty does not apply to any
portion of an underpayment of tax if it is shown that there was
reasonable cause for such portion and that the taxpayer acted in
good faith. Sec. 6664(c)(1).
An “understatement of tax” is substantial if it exceeds the
greater of 10 percent of the tax required to be shown on the
return or $5,000. Sec. 6662(d)(1) and (2).
“Negligence” is defined as any failure to make a reasonable
attempt to comply with the provisions of the Internal Revenue
Code. Sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.
Generally, a taxpayer is negligent if he or she fails to make a
reasonable attempt to ascertain the correctness of a deduction,
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credit, or exclusion on a tax return which would seem to a
reasonable and prudent person to be “too good to be true”. Sec.
1.6662-3(b)(1)(ii), Income Tax Regs. “Disregard” includes any
careless, reckless, or intentional disregard. Sec. 6662(c).
A “substantial valuation misstatement” occurs if the value
of any property or adjusted basis of any property claimed on an
income tax return is 200 percent or more of the correct amount.
Sec. 6662(e)(1)(A); sec. 1.6662-5(e)(1), Income Tax Regs. If the
valuation misstatement is 400 percent or more of the correct
amount, the misstatement is considered a “gross valuation
[misstatement]”, and the 20-percent penalty is increased to 40
percent. Sec. 6662(h).
Only one accuracy-related penalty may be applied with
respect to any given portion of an underpayment, even if that
portion is subject to more than one of the types of misconduct
described in section 6662. Sec. 1.6662-2(c), Income Tax Regs.
In the notice of deficiency, respondent determined that
petitioners are liable for accuracy-related penalties under
section 6662(c) for negligence, section 6662(d) for a substantial
understatement of income tax, section 6662(e) for a substantial
valuation misstatement, and section 6662(h) for a gross valuation
misstatement. Section 1.6662-2(c), Income Tax Regs., prevents
respondent from stacking these types of misconduct to impose a
penalty greater than the maximum penalty of 20 percent on any
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given portion of an underpayment (or 40 percent if such portion
is attributable to a gross valuation misstatement).
Petitioners concede that they were not entitled to claim
Schedule F losses of $184,000 for taxable year 1994 and $46,395
for taxable year 1995. After adjustment of petitioners’ income
tax returns to account for the disallowance of the Schedule F
losses, petitioners’ understatements of income tax for 1994 and
1995 exceeded 10 percent of the tax required to be shown on the
return and $5,000. Accordingly, there was a “substantial
understatement of income tax” in 1994 and 1995 for purposes of
section 6662(d). Because the “anti-stacking rule” of section
1.6662-2(c), Income Tax Regs., limits the accuracy-related
penalty under section 6662 to 20 percent, it is not necessary for
us to consider whether petitioners were negligent for purposes of
section 6662(c).
However, since the 20-percent penalty may be increased to 40
percent if the portion of the underpayment is attributable to a
gross valuation misstatement, we must consider the applicability
of section 6662(h). On their 1994 return, petitioners claimed
“depreciation and section 179 expenses” of $165,625 and “Expense
for the Cost Basis of Purchased Cattle that Died in 1994" of
$51,162. On their 1995 return, petitioners reported $46,395 in
“depreciation and section 179 expenses” and a net $3 loss from
the sale of cattle based upon a gross sale price of $178,500 less
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a cost basis of $317,733 (adjusted by $139,230 for depreciation).
Petitioners stipulated and were deemed to admit that they did not
incur these expenses. Respondent determined that petitioners’
adjusted basis for the assets giving rise to these expense
deductions was zero, resulting in a valuation misstatement of 400
percent or more of the correct amount for purposes of section
6662(h). See sec. 1.6662-5(g), Income Tax Regs. As stated
above, petitioners bear the burden of proving that respondent’s
determinations under section 6662 are incorrect. Petitioners did
not appear for their trial and did not introduce any evidence to
contest these determinations. Consequently, we sustain the
imposition of a 40-percent penalty under section 6662(h) for a
gross valuation misstatement with regard to the portion of the
underpayment of tax attributable to the items described in this
paragraph. See Zirker v. Commissioner, 87 T.C. 970, 979-980
(1986).
Petitioners contend that an accuracy-related penalty should
not be imposed because they acted with reasonable cause and in
good faith for purposes of the “reasonable cause exception” of
section 6664(c)(1). The determination of whether a taxpayer
acted with reasonable cause and in good faith is made on a case-
by-case basis, taking into account all the pertinent facts and
circumstances. Sec. 1.6664-4(b)(1), Income Tax Regs. Generally,
the most important factor is the extent of the taxpayer’s effort
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to assess his or her proper tax liability. Id. Under some
circumstances, reasonable cause may be established when a
taxpayer shows that he or she reasonably relied on the advice of
an independent and competent tax professional. United States v.
Boyle, 469 U.S. 241, 250-251 (1985); Weis v. Commissioner, 94
T.C. 473, 487 (1990); Peete v. Commissioner, T.C. Memo. 2004-31;
sec. 1.6664-4(b)(1), Income Tax Regs.
We do not believe that petitioners have satisfied their
burden of proof in regard to the reasonable cause exception. As
stated earlier, while we have given careful consideration to the
arguments set forth by petitioners’ counsel, Mr. Morford, we
cannot overlook petitioners’ failure to appear at trial and
provide testimony on the facts underlying their participation in
the Hoyt cattle operation and the reasonableness behind the
underpayments of tax on their income tax returns for 1994 and
1995.
The limited facts that are part of the record do not support
a finding that petitioners acted with reasonable cause and in
good faith. Petitioners were college-educated professionals who
must have realized that the overall benefits they received from
their investment in the Hoyt cattle operation were simply “too
good to be true”. Although they were not associated with the
Hoyt cattle operation until October 1995, petitioners claimed
$184,000 in cattle losses on their 1994 income tax return.
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Reporting losses from a transaction entered into in taxable year
1995 on their 1994 income tax return simply does not demonstrate
that petitioners exercised ordinary care and prudence in
determining their tax obligation.
Petitioners argue that they relied in good faith upon the
tax advice and tax preparation services they received from Mr.
Hoyt and Laguna Tax Service, an entity operated by Mr. Hoyt.
Although Mr. Hoyt was an enrolled agent authorized to practice
before the IRS, any tax advice from either Mr. Hoyt or Laguna Tax
Service cannot be characterized as advice from an independent and
competent tax professional. Rather, such advice is better
classified as sales promotion. See Vojticek v. Commissioner,
T.C. Memo. 1995-444. Since petitioners were required to remit to
the Hoyt cattle operation 75 percent of their tax refunds,
representations made by Mr. Hoyt or Laguna Tax Service would
clearly be self-serving and unreliable. Petitioners did not
consult any competent tax professional from outside the Hoyt
cattle operation.
For the foregoing reasons, we sustain respondent’s
determinations that petitioners are liable for accuracy-related
penalties for 1994 and 1995.
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To reflect the amounts of the additions to tax and penalties
as discussed above,
Decision will be entered
under Rule 155.