                  T.C. Memo. 2001-261



                UNITED STATES TAX COURT



     JERRY J. AND SUSAN N. LEBOUEF, Petitioners v.
      COMMISSIONER OF INTERNAL REVENUE, Respondent



Docket No. 15785-99.                    Filed October 3, 2001.



     R determined a deficiency for Ps’ 1993 taxable
year based primarily on disallowance of: (1) Amounts
claimed for cost of goods sold with respect to a sole
proprietorship and (2) a loss claimed with respect to a
partnership interest.

     Held: Ps have failed to overcome their initial
reporting of $244,270 as gross receipts from their sole
proprietorship and, for lack of substantiation, are not
entitled to offset such receipts by an identical amount
for cost of goods sold.

     Held, further, Ps are not entitled to deduct a
loss of $19,791 allegedly attributable to their
interest in a partnership.

     Held, further, Ps are liable for the sec.
6651(a)(1), I.R.C., addition to tax for failure timely
to file their 1993 income tax return.
                                 - 2 -

          Held, further, Ps are liable for the sec. 6662(a),
     I.R.C., accuracy-related penalty.


     Larry D. Vince, for petitioners.

     Nguyen-Hong K. Hoang, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     NIMS, Judge:     Respondent determined a Federal income tax

deficiency for petitioners’ 1993 taxable year in the amount of

$93,957.   Respondent also determined an addition to tax of

$23,161 pursuant to section 6651(a)(1) and an accuracy-related

penalty of $18,791 under section 6662(a).

     The issues for decision are:

     (1) Whether petitioners, having reported gross receipts of

$244,270 on their 1993 Schedule C, Profit or Loss From Business,

are entitled to offset such receipts by an identical amount as

cost of goods sold;

     (2) whether petitioners are entitled to deduct a claimed

loss of $19,791;

     (3) whether petitioners are liable for the section

6651(a)(1) addition to tax for failure timely to file their 1993

income tax return; and

     (4) whether petitioners are liable for the section 6662(a)

accuracy-related penalty.
                                - 3 -

     Additional adjustments to petitioners’ exemptions, itemized

deductions, self-employment tax, and deduction for self-

employment tax are computational in nature and will be resolved

by our holdings on the foregoing issues.

     Unless otherwise indicated, all section references are to

sections of the Internal Revenue Code in effect for the year at

issue, and all Rule references are to the Tax Court Rules of

Practice and Procedure.

     To facilitate disposition of the above issues, we shall

first make general findings of fact and then combine our findings

and opinion with respect to each issue.

I.   General Findings of Fact

     Some of the facts have been stipulated and are so found.

The stipulations of the parties, with accompanying exhibits, are

incorporated herein by this reference.     At the time the petition

was filed in this case, petitioners resided in Newport Beach,

California.

     Petitioners requested two extensions of time to file their

1993 Form 1040, U.S. Individual Income Tax Return, both of which

were granted.   Taking these extensions into account, petitioners’

return was due on October 15, 1994.     Respondent received

petitioners’ 1993 Form 1040 on December 15, 1995.     The return was

signed by both petitioners and by their preparer Anthony Aulisio,

Jr., CPA.   Attached to their 1993 return, petitioners included
                               - 4 -

both a Schedule C, Profit or Loss From Business, for LeBouef

Company and a Form 4797, Sales of Business Property, relating to

Toro Leasing Company.

     On the Schedule C, petitioner Jerry LeBouef is listed as the

sole proprietor of LeBouef Company, and the principal business of

the entity is stated to be “CONSTRUCTION”.   Additionally, the

question “Did you ‘materially participate’ in the operation of

this business during 1993?” is responded to with a check in the

box marked “Yes”.   On the Schedule C, petitioners reported gross

receipts of $244,270 and cost of goods sold of $244,270.    The

explanation given for the cost of goods sold figure is “PROJECT

COSTS”.   After deduction of $600 in business expenses, LeBouef

Company is shown as having incurred a net loss of $600.

     The record also contains petitioners’ returns for the years

immediately preceding and following the period at issue.    The

Schedule C for LeBouef Company attached to petitioners’ 1992 Form

1040 shows gross receipts of $60,000, cost of goods sold “PROJECT

COSTS” of $55,000, and business expenses of $1,763, for a net

profit of $3,237.   In 1994, petitioners reported gross receipts

for LeBouef Company of $24,500, cost of goods sold “PROJECT

COSTS” of $24,500, business expenses of $14,500, and a net loss

of $14,500.

     On their Form 4797 for 1993, petitioners claimed a loss of

$19,791 with respect to business property of Toro Leasing
                                 - 5 -

Company.    During 1993, Toro Leasing was a partnership in which

Mr. LeBouef and Edward Silveri were each 50 percent general

partners who shared equally in profits and losses.    Toro Leasing

filed a Form 1065, U.S. Partnership Return of Income, reflecting

a Form 4797 loss of $39,582 on sales or exchanges of business

property.    Attached is a Schedule K-1, Partner’s Share of Income,

Credits, Deductions, etc., showing $19,791 as Mr. LeBouef’s

portion of this loss.

      At some time prior to or during April of 1998, respondent

commenced an examination of petitioners’ 1993 return.    Revenue

Agent Ellen Nierich conducted this examination, which culminated

in the issuance of a notice of deficiency to petitioners on July

6, 1999.    The adjustments made in this notice are the subject of

the present litigation.

II.   Burden of Proof

      We begin with a threshold observation regarding burden of

proof.   As a general rule, the Commissioner’s determinations are

presumed correct, and the taxpayer bears the burden of proving

otherwise.    Rule 142(a).   Recently enacted section 7491, however,

may operate in specified circumstances to place the burden on the

Commissioner.    Because petitioners make certain statements on

brief that can be interpreted as an appeal to the benefits of

section 7491, we emphasize that the statute is applicable only to

court proceedings that arise in connection with examinations
                                - 6 -

commencing after July 22, 1998.    Internal Revenue Service

Restructuring & Reform Act of 1998, Pub. L. 105-206, sec.

3001(c), 112 Stat. 685, 727.    Since the record here indicates

that the examination in this case was ongoing by at least April

of 1998, the burden remains on petitioners to establish that

respondent’s determinations are erroneous.

III.    Schedule C Reporting

       A.   General Rules

       As a basic premise, the income of a sole proprietorship must

be included in calculating the income and tax liabilities of the

individual owning the business.    Sec. 61(a)(2).    The net profit

or loss of such an enterprise is generally computed on Schedule C

by subtracting cost of goods sold and ordinary and necessary

business expenses from the gross receipts of the venture.

       In this connection, taxpayers are required to maintain

records sufficient to establish the existence and amount of all

items reported on the tax return, including both income and

offsets or deductions therefrom.    Sec. 6001; Hradesky v.

Commissioner, 65 T.C. 87, 89-90 (1975), affd. 540 F.2d 821 (5th

Cir. 1976); sec. 1.6001-1(a), Income Tax Regs.      Additionally,

statements made on a tax return signed by the taxpayer have long

been considered admissions, and such admissions are binding on

the taxpayer absent cogent evidence indicating they are wrong.

Waring v. Commissioner, 412 F.2d 800, 801 (3d Cir. 1969), affg.
                               - 7 -

T.C. Memo. 1968-126; Lare v. Commissioner, 62 T.C. 739, 750

(1974), affd. without published opinion 521 F.2d 1399 (3d Cir.

1975); Kaltreider v. Commissioner, 28 T.C. 121, 125-126 (1957),

affd. 255 F.2d 833 (3d Cir. 1958); Smith v. Commissioner, T.C.

Memo. 1997-109, affd. without published opinion 129 F.3d 1260

(4th Cir. 1997); Rankin v. Commissioner, T.C. Memo. 1996-350,

affd. 138 F.3d 1286 (9th Cir. 1998); Sirrine Bldg. No. 1 v.

Commissioner, T.C. Memo. 1995-185, affd. without published

opinion 117 F.3d 1417 (5th Cir. 1997).

     B.   Contentions of the Parties

     Throughout this litigation and the earlier examination of

their return, petitioners have maintained that the sole

proprietorship, LeBouef Company, was inactive during the taxable

year 1993 and neither earned any income nor incurred any costs of

goods sold.   Rather, petitioners contend that the gross receipts

reflected on their Schedule C were in fact income of LeBouef

Company, Inc., a corporate entity owned by Mr. LeBouef.

Petitioners explain that prior to 1987 Mr. LeBouef operated his

construction enterprise as a sole proprietorship and thereafter

incorporated the business as LeBouef Company, Inc.   They allege,

however, that certain customers mistakenly continued to use the

sole proprietorship’s employer identification number when

reporting payments for work performed to the Internal Revenue

Service (IRS) on Forms 1099.   Petitioners further assert that
                                - 8 -

they believed such occurred in 1993 to the extent of $244,270,

and they label their Schedule C reporting of this amount as gross

receipts and then zeroing out that figure by an identical cost of

goods sold as “disclosure” and as “a practical solution” for

dealing with their situation.

     Respondent, in contrast, characterizes this case as

involving an unrebutted admission of income coupled with a

failure to substantiate expenditures subtracted therefrom.

     C.   Discussion

     On the record before us, we conclude that petitioners have

failed to meet their burden of establishing that LeBouef Company

was inactive and did not receive the reported amounts in 1993.

As we explain below, our conclusion rests on two primary bases:

(1) The absence of corroborating evidence beyond the testimony of

Mr. LeBouef and Mr. Aulisio that the sole proprietorship did not

operate in 1993, and (2) the presence of a bank deposits analysis

by respondent indicating income significantly greater than

petitioners’ reported income would be if the $244,270 were

eliminated.

     First, Mr. LeBouef and Mr. Aulisio testified that LeBouef

Company was not active in 1993.   Neither, however, proved

convincing.   Mr. LeBouef was generally vague and could not

specifically identify the genesis of either the $244,270 gross

receipts or the $600 business deduction recorded on his Schedule
                               - 9 -

C.   Mr. Aulisio testified that it was common practice in the

accounting industry, in order to deal with Form 1099 amounts

misreported to the IRS by third parties, to “make full disclosure

by putting the exact same number in and out.”   Aside from the

questionable validity of this statement, we find it noteworthy

that Mr. Aulisio did more than just report and subtract the same

numerical figure.   He affirmatively labeled the cost of goods

sold “PROJECT COSTS”, a term which connotes active operations to

a far greater extent than it discloses the alleged situation of

inactivity.

      Webster’s defines “disclose” as “to expose to view” and “to

make known: open up to general knowledge * * *; esp: to reveal in

words (something that is secret or not generally known):

DIVULGE”.   Webster’s Third New International Dictionary 645

(1976).   Accordingly, we take issue with petitioners’ and Mr.

Aulisio’s characterization of the Schedule C reporting as a form

of disclosure to the IRS.   To report that a particular entity

earned gross receipts, incurred project costs and business

expenses, and operated at a loss, all with the material

participation of its proprietor, hardly exposes, makes known,

reveals, or divulges that the entity was inactive, that payments

were misreported by third parties, and that the income shown on

the Schedule C was actually that of a corporation.   If the true

intent of petitioners and Mr. Aulisio had been to disclose the
                              - 10 -

facts now postulated, it seems unlikely that the presentation of

information in petitioners’ Schedule C is the vehicle they would

have selected.

     Furthermore, the record is devoid of evidence which would

lend credence to petitioners’ purported reason for showing

$244,270 of gross receipts in the first instance.   None of the

supposedly erroneous Forms 1099 have been produced.   Mr. Aulisio

even testified that he simply relied on the word of petitioners’

bookkeeper in determining the total amount, and he claimed to

have seen only one Form 1099 representing a small percentage of

the sum in question.   Significantly, the bookkeeper was not

called as a witness, and we cannot assume that his or her

testimony would have been favorable to petitioners.   In addition,

during examination of petitioners’ 1993 return and upon hearing

Mr. Aulisio’s explanation at that time, Ms. Nierich checked the

IRS records but could find no Forms 1099 issued to the sole

proprietorship.

     In fact, the only documents in the record which petitioners

claim support their position are the combined annual reports of

LeBouef Company and LeBouef Company, Inc., for 1992 and 1993.

These items, however, are of little use to the Court since the

balance sheets, income statements, and cashflow statements

included therein do not differentiate between the entities in

their presentation of financial data.   Also, we note that to the
                              - 11 -

extent the financials indicate that one or both of the entities

operated at a loss, a loss is not necessarily equivalent to the

absence of taxable activities.   Moreover, although the 1992

report contains a note stating that the sole proprietorship was

inactive in 1992, no similar statement was included in the 1993

report and even the 1992 remark is entitled to little weight here

because of the difficulty in reconciling that assertion with

other evidence in the record and because of the inherent nature

of annual reports.

     With regard to evidentiary discrepancies, petitioners’ own

return for 1992 reflects a net profit for the proprietorship of

$3,237 in that year, thus obfuscating any potential correlation

between claimed inactivity for financial business purposes and

the receipt of taxable income.   Additionally, and further calling

into question claims that any inactivity which might have existed

in 1992 continued throughout 1993, the record contains a copy of

a check for $160,000 dated April 21, 1993, and issued to “LE

BOUEF COMPANY” by “The CIT Group/Equipment Financing, Inc.”    The

parties stipulated that this check represented “a loan made to

LeBouef Company sole proprietorship for the purpose of purchasing

construction equipment.”   Again, equipment purchases seem

difficult to square with claims of inactivity.
                               - 12 -

     As concerns the nature of annual reports in general, such

reports are derived from the representations of management.    And,

while financial statements are often verified through audit, to a

lesser or greater extent, we have no information as to what, if

any, steps were taken to check the proprietorship’s claimed

inactivity in 1992 or even as to what exactly was meant by use of

the term “inactive” within the context of the annual report.

     We next turn to the implications of respondent’s bank

deposits analysis.   In the course of her examination of

petitioners’ 1993 return, Ms. Nierich performed a bank deposits

analysis in an attempt to verify petitioners’ gross receipts and

income.   Bank deposits are considered prima facie evidence of

income, and a bank deposits analysis typically encompasses the

following:   (1) A totaling of bank deposits; (2) the elimination

from such total of any amounts derived from duplicative transfers

or nontaxable sources of which the Commissioner has knowledge;

and (3) the further reduction of the adjusted total by any

deductible or offsetting expenditures of which the Commissioner

is aware.    Clayton v. Commissioner, 102 T.C. 632, 645-646 (1994);

DiLeo v. Commissioner, 96 T.C. 858, 868 (1991), affd. 959 F.2d 16

(2d Cir. 1992).   The burden rests on the taxpayer to prove

additional nontaxable sources for deposits and to substantiate

greater allowable expenditures.   Rule 142(a); Clayton v.

Commissioner, supra at 645.
                                - 13 -

     During 1993, four bank accounts were maintained as personal

accounts of petitioners, and three were maintained in the name of

the sole proprietorship.   Total deposits of $943,147 were made

into these accounts in 1993.    After subtracting $281,708 for

interaccount transfers, $269,551 for loans, $30 for overdrafts,

and $7,023 for other nontaxable items, Ms. Nierich calculated net

taxable deposits of $384,835.    Excluding the $244,270 of gross

receipts listed on the LeBouef Company Schedule C, petitioners

reported total gross income on their 1993 return of less than

$60,000, a difference of more than $300,000 when compared to the

bank deposits analysis.

     While respondent does not treat this as an unreported income

case and is not attempting to tax petitioners on receipts not

shown in their own return, the analysis performed does buttress

the conclusion that petitioners and/or their sole proprietorship

received substantial moneys which would escape taxation if we

were to accede to their version of the facts before us.

Furthermore, we note that although petitioners dispute several

aspects of the bank deposits analysis, they have offered no

documentary evidence tracing any particular deposits to

nontaxable sources and, thus, have not substantiated their

allegations that certain additional amounts should be treated as

nontaxable.
                               - 14 -

      To summarize, petitioners have failed to overcome their

initial reporting of $244,270 as gross receipts of their sole

proprietorship.   Moreover, because petitioners also readily

concede that they have no substantiation for the identical amount

claimed as cost of goods sold, we sustain respondent’s

determination with respect to the adjustment to petitioners’

Schedule C income.

IV.   Partnership Loss

      As previously indicated, petitioners deducted on their 1993

return $19,791, representing their 50-percent share of a loss

allegedly incurred by Toro Leasing on a disposition of business

property.    Respondent disallowed the claimed loss in the notice

of deficiency on the grounds that petitioners failed to

“establish that the amount shown was (a) a loss, and (b)

sustained by you”.   Petitioners’ position on this issue is that

they “are entitled to rely on the K-1 from Toro Leasing, a

partnership, as adequate substantiation for the loss”.

Petitioners apparently believe that because Ms. Nierich did not

audit the partnership, the Schedule K-1 is not subject to

challenge.   Existing caselaw, however, belies petitioners’

interpretation of the burden to be borne by taxpayers in this

situation.

      The parties stipulated that “Toro Leasing is not governed by

the provisions in the Tax Equity and Fiscal Responsibility Act of
                              - 15 -

1982 (TEFRA) embodied in subchapter C of chapter 63 of the

Internal Revenue Code.”   Toro Leasing falls within the “small

partnership” exception contained in section 6231(a)(1)(B)(i) and

thus is not under the purview of the unified partnership-level

audit procedures implemented by TEFRA.   In such circumstances,

respondent has no obligation to conduct an audit of the

partnership and, as the following cases illustrate, may demand

that the individual taxpayer substantiate specific facts

underlying items allegedly derived from partnership activities.

     For example, in Johnson v. Commissioner, T.C. Memo. 1999-

412, the taxpayers claimed partnership losses.   After expressly

assuming that the partnerships at issue were small partnerships

within the meaning of section 6231(a)(1), we reasoned:

          Section 6001 requires that a taxpayer liable for
     any tax shall maintain such records, render such
     statements, make such returns, and comply with such
     regulations as the Secretary may from time to time
     prescribe. To be entitled to a deduction, therefore, a
     taxpayer is required to substantiate the deduction
     through the maintenance of books and records.

          Petitioner has not established that the entities
     in question incurred a loss in 1992, or any other year.
     At most, petitioner has established that the
     partnership entities defaulted on the debt in the
     amount of $2,590,001 in 1992. Even if petitioner had
     established that the partnerships had incurred a loss,
     petitioner would not be entitled to a flow-through loss
     deduction as petitioner has not established his bases
     in his partnership interests. [Id.]
                              - 16 -

     Similarly, in Bukove v. Commissioner, T.C. Memo. 1991-76,

the taxpayer claimed investment tax credits attributable to

various partnership interests, some TEFRA and some non-TEFRA.    We

stated:

          To the extent that the claimed ITC is attributable
     to one or more non-TEFRA partnerships, petitioner must
     prove (1) the identity of the partnership through which
     the ITC is claimed; (2) the identity, cost, and date
     placed in service of any qualifying property; and (3)
     whether the partnership used the property in a trade or
     business. * * *

          Petitioner introduced no evidence regarding the
     source of the ITC’s, other than * * * [petitioner’s
     return preparer’s] blanket assertion that they were
     generated by Dickinson and NDL. Petitioner introduced
     no evidence to establish what qualifying property was
     acquired, that the property was ever placed in service,
     or that the property was actually used in a trade or
     business. No partnership records were presented and no
     partnership personnel testified. Rather, petitioner’s
     evidence consisted of vague testimony * * * [Id.]

     With respect to the case at bar, the record is equally

bereft of evidence that could provide a factual underpinning of

the type demanded in Johnson v. Commissioner, supra, and Bukove

v. Commissioner, supra.   Contrary to petitioners’ assertions, it

has long been held that statements made in tax returns do not

constitute proof of the transactions underlying the reported

figures.   Seaboard Commercial Corp. v. Commissioner, 28 T.C.

1034, 1051 (1957); Halle v. Commissioner, 7 T.C. 245, 247, 249-

250 (1946), affd. 175 F.2d 500 (2d Cir. 1949).   Accordingly, the

Schedule K-1 on which petitioners rely cannot be regarded as more

than an assertion of their claim.   We also note that Mr. Aulisio
                               - 17 -

prepared both the partnership return and petitioners’ individual

return, making it particularly difficult to construe either as

corroboration for the other.

     Petitioners also point out that the combined financial

report for LeBouef Company and LeBouef Company, Inc., contains an

unaudited financial statement for Toro Leasing reflecting a line

item of $104,747 for “Loss on disposal of fixed assets”.

However, such statement again is merely a representation by

management and falls far short of proving that specific business

property was disposed of at a loss correlating to that shown on

the Schedule K-1 and petitioners’ Form 4797.

     We simply lack any documentary evidence, such as receipts,

bills of sale, or partnership books and records, to affirmatively

establish that the items of business property listed on the

partnership return were in fact acquired and sold at the amounts

claimed.   Hence, petitioners have failed to establish even that

the purported loss was sustained by Toro Leasing.   We hold that

petitioners are not entitled to deduct the $19,791 reported on

their Form 4797.

V.   Section 6651(a)(1) Addition to Tax

      Section 6651(a)(1) imposes an addition to tax for

delinquency in filing returns and provides in relevant part as

follows:
                               - 18 -

     SEC. 6651.   FAILURE TO FILE TAX RETURN OR TO PAY TAX.

            (a) Addition to the Tax.--In case of failure--

                 (1) to file any return required under
            authority of subchapter A of chapter 61 * * * , on
            the date prescribed therefor (determined with
            regard to any extension of time for filing),
            unless it is shown that such failure is due to
            reasonable cause and not due to willful neglect,
            there shall be added to the amount required to be
            shown as tax on such return 5 percent of the
            amount of such tax if the failure is for not more
            than 1 month, with an additional 5 percent for
            each additional month or fraction thereof during
            which such failure continues, not exceeding 25
            percent in the aggregate;* * *

     The Supreme Court has characterized the foregoing section as

imposing a civil penalty to ensure timely filing of tax returns

and as placing on the taxpayer “the heavy burden of proving both

(1) that the failure did not result from ‘willful neglect,’ and

(2) that the failure was ‘due to reasonable cause’”, in order to

escape the penalty.    United States v. Boyle, 469 U.S. 241, 245

(1985).   “Willful neglect” denotes “a conscious, intentional

failure or reckless indifference.”      Id.   “Reasonable cause”

correlates to “ordinary business care and prudence”.       Id. at 246

& n.4; sec. 301.6651-1(c)(1), Proced. & Admin. Regs.

     Here, petitioners did not file their tax return for 1993

until December of 1995.    The parties have also stipulated that

the return was due, taking extensions into account, on October

15, 1994.    Since petitioners have offered no explanation for the

untimeliness, either at trial or on brief, they have failed to
                                - 19 -

establish any reasonable cause.    We therefore hold that

petitioners are liable for the section 6651(a)(1) delinquency

addition to tax.

VI.   Section 6662(a) Accuracy-Related Penalty

      Subsection (a) of section 6662 imposes an accuracy-related

penalty in the amount of 20 percent of any underpayment that is

attributable to causes specified in subsection (b).    Subsection

(b) of section 6662 then provides that among the causes

justifying imposition of the penalty are:    (1) Negligence or

disregard of rules or regulations and (2) any substantial

understatement of income tax.

      “Negligence” is defined in section 6662(c) as “any failure

to make a reasonable attempt to comply with the provisions of

this title”, and “disregard” as “any careless, reckless, or

intentional disregard.”   Case law similarly states that

“‘Negligence is a lack of due care or the failure to do what a

reasonable and ordinarily prudent person would do under the

circumstances.’”   Freytag v. Commissioner, 89 T.C. 849, 887

(1987) (quoting Marcello v. Commissioner, 380 F.2d 499, 506 (5th

Cir. 1967), affg. on this issue 43 T.C. 168 (1964) and T.C. Memo.

1964-299), affd. 904 F.2d 1011 (5th Cir. 1990), affd. 501 U.S.

868 (1991).   Pursuant to regulations, “‘Negligence’ also includes
                                - 20 -

any failure by the taxpayer to keep adequate books and records or

to substantiate items properly.”    Sec. 1.6662-3(b)(1), Income Tax

Regs.

     A “substantial understatement” is declared by section

6662(d)(1) to exist where the amount of the understatement

exceeds the greater of 10 percent of the tax required to be shown

on the return for the taxable year or $5,000 ($10,000 in the case

of a corporation).   For purposes of this computation, the amount

of the understatement is reduced to the extent attributable to an

item:   (1) For which there existed substantial authority for the

taxpayer’s treatment thereof, or (2) with respect to which

relevant facts were adequately disclosed on the taxpayer’s return

or an attached statement and there existed a reasonable basis for

the taxpayer’s treatment of the item.    See sec. 6662(d)(2)(B).

     An exception to the section 6662(a) penalty is set forth in

section 6664(c)(1) and reads:    “No penalty shall be imposed under

this part with respect to any portion of an underpayment if it is

shown that there was a reasonable cause for such portion and that

the taxpayer acted in good faith with respect to such portion.”

     Regulations interpreting section 6664(c) state:

          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 pertinent facts
     and circumstances. * * * Generally, the most important
     factor is the extent of the taxpayer’s effort to assess
     the taxpayer’s proper tax liability. * * * [Sec.
     1.6664-4(b)(1), Income Tax. Regs.]
                               - 21 -

       Furthermore, reliance upon the advice of an expert tax

preparer may, but does not necessarily, demonstrate reasonable

cause and good faith in the context of the section 6662(a)

penalty.    See id.; see also Freytag v. Commissioner, supra at

888.    Such reliance is not an absolute defense, but it is a

factor to be considered.    See Freytag v. Commissioner, supra at

888.    In order for this factor to be given dispositive weight,

the taxpayer claiming reliance on a professional must show, at

minimum, that (1) the preparer was supplied with correct

information and (2) the incorrect return was a result of the

preparer’s error.    See, e.g., Westbrook v. Commissioner, 68 F.3d

868, 881 (5th Cir. 1995), affg. T.C. Memo. 1993-634; Cramer v.

Commissioner, 101 T.C. 225, 251 (1993), affd. 64 F.3d 1406 (9th

Cir. 1995); Ma-Tran Corp. v. Commissioner, 70 T.C. 158, 173

(1978); Pessin v. Commissioner, 59 T.C. 473, 489 (1972); Garcia

v. Commissioner, T.C. Memo. 1998-203, affd. without published

opinion 190 F.3d 538 (5th Cir. 1999).

       The notice of deficiency issued to petitioners asserted

applicability of the section 6662(a) penalty on account of both

negligence and/or substantial understatement.    (The notice also

referenced substantial valuation overstatement as an additional

alternative ground, see sec. 6662(b)(3), but since valuation was

not a focus of this case, we disregard the apparent boilerplate

reference.)    Petitioners seek to avoid this penalty on the basis
                              - 22 -

of professional reliance and information disclosure.     Petitioners

assert that they relied upon Mr. Aulisio and, as previously

indicated, characterize their situation as one of “full

disclosure”.   We, however, disagree with petitioners’ assessment

that their actions and reporting were sufficient to avoid the

penalty.

     First, we reiterate that petitioners’ method of reporting

fell far short of “disclosing” relevant facts regarding the

proprietorship’s alleged inactivity to respondent.     The return

also did not reveal facts underlying the loss deduction.

Petitioners failed to maintain adequate records to support the

amounts claimed on their return.   Moreover, there exists no

substantial authority for reducing income either by costs or by a

loss that cannot be substantiated.     Given these facts, we

conclude that unless petitioners are entitled to relief under the

section 6664(c) exception, petitioners are liable for the

accuracy-related penalty on account of negligence and substantial

understatement.

     Turning then to the question of reasonable cause, we further

conclude that petitioners have failed to establish exculpatory

reliance on Mr. Aulisio.   Most importantly, there has been no

showing that Mr. Aulisio was provided with accurate information

such that any errors are attributable to him and not to

petitioners.   Mr. Aulisio admits that the figures reported for
                              - 23 -

Schedule C gross receipts and cost of goods sold were based on

oral representations of petitioners’ bookkeeper.   No indication

has been given as to what documentation led to the partnership

loss deduction.   The record is silent as to petitioners’ personal

role in supplying information.   We do not know whether

petitioners, before signing their Form 1040, even questioned

their preparer as to why an allegedly inoperative business was

returned in such a manner.   In sum, we cannot with any confidence

say that petitioners took reasonable care in attempting to

ascertain their proper tax liability.   We hold that petitioners

are liable for the section 6662(a) accuracy-related penalty.

     To reflect the foregoing,



                                         Decision will be entered

                                    for respondent.
