                     114 T.C. No. 22



                 UNITED STATES TAX COURT



            FREDIE LYNN CHARLTON, Petitioner v.
       COMMISSIONER OF INTERNAL REVENUE, Respondent

SARAH K. HAWTHORNE, f.k.a. SARAH K. CHARLTON, Petitioner v.
       COMMISSIONER OF INTERNAL REVENUE, Respondent



 Docket Nos. 11412-98, 11861-98.    Filed May 16, 2000.


      Ps were married in 1989, separated in 1995, and
 divorced in 1996. In 1994, W operated Medi-Task, a
 physician’s transcription business. H was employed
 full time by a large corporation until September 1994.
 In the fall of 1994, he moved to a lake and began to
 renovate some rental cabins. Ps filed a joint tax
 return for 1994 in which they reported that they had
 self-employment tax liability for the transcription
 business and deducted rental cabin expenses.

      R determined a deficiency based in part on
 adjustments to Ps’ self-employment tax and denial of
 deductions relating to the cabins. Ps filed petitions
 disputing R’s determination. Ps also alleged they each
 qualified for relief as an innocent spouse.

      H contends that he qualifies for relief under sec.
 6015(b) and (c), I.R.C. W contended at trial that she
                                -2-

     qualifies for relief under sec. 6015(b), (c), and (f),
     I.R.C., but now contends that she qualifies for relief
     only under sec. 6015(f), I.R.C. R contends that the
     Tax Court lacks jurisdiction to decide W’s claim under
     sec. 6015(f), I.R.C.

          Held: All transcription-related self-employment
     income is allocated to W under secs. 6017 and
     1402(a)(5)(A), I.R.C.

          Held, further, Ps’ rental cabin expenses are not
     deductible because they are preoperational startup
     expenses. See sec. 195, I.R.C.

          Held, further, H does not qualify for relief under
     sec. 6015(b), I.R.C., but he qualifies for limitation
     of liability under sec. 6015(c), I.R.C., to the extent
     stated herein.

          Held, further, We have jurisdiction to review
     whether relief is available under sec. 6015(f), I.R.C.



     Fredie Lynn Charlton, pro se.

     Sarah K. Hawthorne, pro se.

     Deborah H. Delgado, Carl D. Inskeep, and Lewis J. Hubbard,

for respondent.


     COLVIN, Judge:   Respondent determined that, for 1994,

petitioners were liable for a $15,192 deficiency in income tax

and a $1,731 accuracy-related penalty under section 6662(a).

     Following concessions,1 the issues for decision are:

     1.   Whether all of petitioners’ self-employment income from


     1
        Respondent concedes that petitioners are not liable for
the accuracy-related penalty under sec. 6662 for 1994. Both
petitioners and respondent agree that petitioners understated
Medi-Task gross receipts for 1994 by $22,601 on their 1994
return.
                                    -3-

Medi-Task is allocated to petitioner Sarah K. Hawthorne

(Hawthorne) for purposes of computing self-employment tax for

1994.     We hold that it is.

     2.      Whether petitioners may deduct expenses relating to

their rental cabins in 1994.       We hold that they may not.

     3.      Whether petitioner Fredie Lynn Charlton (Charlton) is

entitled to relief from joint and several liability under section

6015(b) for the income tax deficiency arising from petitioners’

1994 joint return.     We hold that he is not.

     4.      Whether petitioner Fredie Lynn Charlton qualifies for

limitation of liability under section 6015(c) for the income tax

deficiency arising from petitioners’ 1994 joint return.         We hold

that he does to the extent described below.

     5.      Whether we have jurisdiction to review whether relief

is available to petitioner Sarah K. Hawthorne under section

6015(f).     We hold that we do.    Thus, we will delay entry of

decision to permit Hawthorne and respondent to report on the

status of Hawthorne’s application for relief under section

6015(f), and if relief is denied, to file a motion as part of

this docketed case requesting our review of the Secretary’s

denial.

     Section references are to the Internal Revenue Code in

effect for 1994.     Rule references are to the Tax Court Rules of

Practice and Procedure.
                                  -4-

                          FINDINGS OF FACT

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

A.   Petitioners

     Petitioner Sarah K. Hawthorne (Hawthorne) lived in Burnet,

Texas, when she filed her petition.       Petitioner Fredie Lynn

Charlton (Charlton) lived in Buchanan Dam, Texas, when he filed

his petition.    Petitioners lived in Texas, a community property

State, at all times relevant to this case.

     Hawthorne has a college degree in English.       She completed an

accounting class and a marketing class but she did not do well in

them.   Hawthorne did not take any income tax courses.

Petitioners were married in 1989.       Before they were married,

Charlton hired Hawthorne to be an office manager for a large

manufacturing business.

     Charlton was employed full time in Houston, Texas, until

September 1994.    He moved his residence to Buchanan Dam, Texas,

in the fall of 1994.

B.   Medi-Task

     Medi-Task was a physician’s transcription service.

Hawthorne managed Medi-Task and performed most of its day-to-day

operations.   Medi-Task had one employee in 1994.      Independent

contractors did most of the transcribing for Medi-Task.       Charlton

did not devote much time to Medi-Task because he was employed

full time until September 1994.    He was not involved with Medi-
                                -5-

Task’s hiring or marketing.   He did not type any reports for

Medi-Task, but he assisted when there were computer problems.

Hawthorne kept Medi-Task’s business records in petitioners’ home

in a file cabinet next to Charlton’s records.   She deposited

Medi-Task’s gross receipts in Charter Bank of Houston, and Lake

Buchanan State Bank.

     Charlton had access to Medi-Task’s records while he prepared

petitioners’ 1994 return.   Hawthorne prepared and gave Charlton

lists that included all but $22,601 of Medi-Task’s income and all

but $2,050 of Medi-Task’s expenses for 1994.    She also gave him

bank statements for Medi-Task, Forms 1099, Forms W-2, Wages and

Tax Statement, and documents showing Medi-Task’s expenses.

     Charlton received unemployment compensation and VA

disability payments in the last quarter of 1994.   Medi-Task was

Charlton’s and Hawthorne’s only other source of income during

that 3-month period.

     Petitioners signed a personal financial statement on April

15, 1995, which stated that Medi-Task was worth $110,000.

Hawthorne sold Medi-Task in 1995 without Charlton’s consent or

participation and kept the proceeds.

C.   Rental Cabins

     Petitioners bought real property in the spring of 1993 at

Charlton Pointe on Lake Buchanan in Llano County, Texas.    There

were some rental cabins on the property which were built in the
                                -6-

1950's and were rented until 1988 or 1989.

     Petitioners began to rehabilitate the cabins in the fall of

1994.   Charlton spent time in 1994 working on the cabins and

other aspects of the Charlton Pointe property.   Petitioners

incurred expenses for travel to Charlton Pointe and expenses to

rehabilitate the cabins.   However, petitioners rented no cabins

at Charlton Pointe in 1994.   Charlton began renting the cabins in

1998.

D.   Petitioners’ Income Tax Returns

     Charlton used tax return preparation software to prepare

returns for petitioners for 5 years, including 1994.

     Petitioners filed a joint income tax return for 1994.     On

it, they reported profits and losses on Schedules C, Profit or

Loss From Business, for Medi-Task and the cabins.   Charlton used

the gross revenue amounts from the lists Hawthorne prepared to

prepare the return.   He did not review the bank statements.    He

also used the lists that Hawthorne prepared to report Medi-Task’s

expenses.   He decided how to report the expenses on part II of

Schedule C for Medi-Task; e.g., as advertising, legal and

professional services, travel and meals, utilities, wages, and

other expenses.

     Petitioners reported that the Medi-Task income was divided

equally between themselves for self-employment tax purposes.

     Petitioners reported that Charlton had $62,135 in wages for
                                 -7-

1994.   They reported that Medi-Task had gross receipts and gross

income of $147,782, total expenses of $117,588, and net profit of

$30,194.    Petitioners underreported 1994 gross receipts for Medi-

Task by $22,601 and did not deduct $2,050 of Medi-Task expenses.

They reported that they had no income from the cabins and $27,724

in expenses.   Hawthorne examined parts of the 1994 return, such

as the children’s names and Social Security numbers and child

care credits, but otherwise accepted the return that Charlton

prepared.

E.   The Divorce

     Petitioners separated in 1995, after they filed their 1994

return, and were divorced in 1996.     Under the divorce settlement,

Charlton received the rental cabin property and Hawthorne

received Medi-Task.   As required by the divorce settlement,

Charlton deposited petitioners’ 1994 refund check for $4,453 in a

joint bank account at Texas Bank in Burnet, Texas, on June 2,

1995.   Charlton used some of the 1994 refund to pay his personal

expenses.

                               OPINION

A.   Whether All Medi-Task Income Is Attributable to Hawthorne
     for Self-Employment Tax Purposes

     Charlton contends that the Medi-Task income should be

divided equally between him and Hawthorne for self-employment tax

purposes.   Respondent and Hawthorne contend that all of the Medi-

Task income is attributable to Hawthorne and that the self-
                                   -8-

employment tax reported by petitioners for 1994 should be

increased by $6,962.

     Self-employment tax for a husband and wife filing a joint

return is the sum of the taxes computed on the self-employment

income of each spouse.    See sec. 6017.    All of the gross income

and deductions from a trade or business over which one spouse

exercises substantially all of the management and control are

attributable to that spouse.      See sec. 1402(a)(5)(A).   For these

purposes, “management and control” means actual management and

control even if management and control is imputed to the other

spouse under community property laws.      Sec. 1.1402(a)-8(a),

Income Tax Regs.

     Charlton contends that he and Hawthorne jointly operated

Medi-Task and that Medi-Task was a partnership or should be

treated as one.    We disagree.    Hawthorne managed Medi-Task and

performed most of its day-to-day operations.      Charlton had a

full-time job until September 1994, and he also renovated cabins

in 1994.   He did not devote much time to Medi-Task.     We conclude

that all of the Medi-Task income in 1994 is attributable to

Hawthorne for self-employment tax purposes.

B.   Whether Petitioners’ 1994 Expenses for the Cabins Were
     Preoperational Startup Expenses

     Charlton contends that petitioners may deduct $27,724 for

supplies, taxes, travel, utilities, legal and professional
                                 -9-

services, and car and truck expenses for their cabin rental

activity for 1994 under section 162.   We disagree.

     Generally, a taxpayer may not deduct startup expenses.   See

sec. 195(a).   A startup expenditure is any amount:

     (A) paid or incurred in connection with–-

          (i) investigating the creation or acquisition of
          an active trade or business, or

          (ii) creating an active trade or business, or

          (iii) any activity engaged in for profit and for
          the production of income before the day on which
          the active trade or business begins, in
          anticipation of such activity becoming an active
          trade or business, and

     (B) which, if paid or incurred in connection with the
     operation of an existing active trade or business (in the
     same field as the trade or business referred to in
     subparagraph (A)), would be allowable as a deduction for the
     taxable year in which paid or incurred. [Sec. 195(c).]

     Petitioners incurred these expenses before the cabin rental

activity became an active trade or business.   Charlton renovated

the cabins in 1994 but did not rent them or offer them for rent

until 1998.    The cabin rental activity was not an active trade or

business in 1994.   Thus, we conclude that the claimed expenses

were nondeductible startup expenses.

C.   Innocent Spouse Issues

     1.   Procedural Status of Innocent Spouse Issues

     Petitioners each asserted in their petitions that they

qualify for relief as an innocent spouse.   The statutory

provision providing relief for innocent spouses in effect when
                                 -10-

the petitions were filed, section 6013(e), was repealed and

replaced before trial by section 6015.   See Internal Revenue

Service Restructuring and Reform Act of 1998, Pub. L. 105-206,

sec. 3201, 112 Stat. 685, 734.    As a result, neither petitioner

referred to section 6015 in the petitions filed in these cases.

     At trial, the parties consented to treating the petitions as

elections by Charlton and Hawthorne for relief under section

6015(b)(1)(E) (procedures for relief from joint liability

applicable to all joint filers) and section 6015(c)(1)

(procedures to limit liability for divorced and separated

taxpayers).

     Respondent contends that we lack jurisdiction to decide

whether Hawthorne is entitled to equitable relief under section

6015(f).2   We deem petitioners to have amended their petitions to

claim relief under section 6015(b) and (c), and we treat

Hawthorne’s request for relief under section 6015(f) as an

amendment to her petition, seeking our review of her entitlement

to relief under that subsection.




     2
        Hawthorne contended at trial that she was entitled to
relief under sec. 6015(b) and (c). She now concedes that relief
is not available to her under sec. 6015(b) and (c).
                               -11-

     2.    Whether Charlton Is Entitled to Relief From Joint and
           Several Liability for Income Tax for 1994 Under Section
           6015(b)

     Charlton contends that he is entitled to relief from joint

and several liability for income tax for 1994 under section

6015(b).

     Section 6015(b)(1) provides that if:

           (A) a joint return has been made for a taxable
           year;

           (B) on such return there is an understatement of
           tax attributable to erroneous items of one
           individual filing the joint return;

           (C) the other individual filing the joint return
           establishes that in signing the return he or she
           did not know, and had no reason to know, that
           there was such understatement;

           (D) taking into account all the facts and
           circumstances, it is inequitable to hold the other
           individual liable for the deficiency in tax for
           such taxable year attributable to such
           understatement; and

           (E) the other individual elects (in such form as
           the Secretary may prescribe) the benefits of this
           subsection not later than the date which is 2
           years after the date the Secretary has begun
           collection activities with respect to the
           individual making the election,

     then the other individual shall be relieved of
     liability for tax (including interest, penalties, and
     other amounts) for such taxable year to the extent such
     liability is attributable to such understatement.

     Respondent concedes that Charlton qualifies under section

6015(b)(1)(A) because he filed a joint Federal income tax return
                               -12-

for 1994, and section 6015(b)(1)(E) because he elected to seek

relief not later than 2 years after collection activities began.

     Section 6015(b)(1)(C) requires that in signing the return

the individual seeking relief did not know and had no reason to

know of the understatement.   Charlton contends that he did not

know and had no reason to know of the understatement attributable

to Medi-Task because he had no control over Medi-Task’s finances

and was busy with his other business interests.    We disagree.

     Under prior law (former section 6013(e)(1)(C)), in a case of

omitted income, a spouse seeking relief was not permitted to turn

a blind eye to facts that were available to him or her to avoid

liability as an innocent spouse.   See McCoy v. Commissioner, 57

T.C. 732, 734 (1972).   Similarly, a taxpayer who prepares a

return is not relieved of the duty to prepare an accurate return

if the taxpayer relies on summarized information provided by the

taxpayer’s spouse when information upon which the summary is

based is available to the taxpayer.

     Charlton was generally familiar with Medi-Task.   Hawthorne

gave him the bank statements respondent later used in determining

Medi-Task’s income for 1994, Forms 1099 and W-2, and a computer-

generated expense list.   Charlton had unfettered access to Medi-

Task’s financial records.   We conclude that Charlton had reason

to know of Medi-Task’s understatement of income.    Thus, Charlton
                                  -13-

does not qualify for relief as an innocent spouse under section

6015(b)(1).

D.   Whether Charlton Qualifies for Limitation of His Liability
     for Petitioners’ 1994 Income Tax Under Section 6015(c)

     Charlton contends that he qualifies for limitation of

liability for petitioners’ 1994 income tax under section 6015(c)3


     3
         Sec. 6015(c) provides:

          SEC. 6015(c). Procedures to Limit Liability for
     Taxpayers No Longer Married or Taxpayers Legally
     Separated or Not Living Together.--

                (1) In general.--Except as provided in this
           subsection, if an individual who has made a joint
           return for any taxable year elects the application
           of this subsection, the individual’s liability for
           any deficiency which is assessed with respect to
           the return shall not exceed the portion of such
           deficiency properly allocable to the individual
           under subsection (d).

                *     *    *      *      *   *   *    *

                (3)   Election.--

                     (A) Individuals eligible to make
                election.--

                           (i) In general.--An individual
                      shall only be eligible to elect the
                      application of this subsection if–

                                (I) at the time such election
                           is filed, such individual is no
                           longer married to, or is legally
                           separated from, the individual with
                           whom such individual filed the
                           joint return to which the election
                           relates; or

                                  (II) such individual was not a
                                                       (continued...)
                                 -14-

for the portion of the deficiency relating to Medi-Task.

Respondent and Hawthorne contend that he does not.    Hawthorne

makes no arguments that substantially differ from respondent’s on

this point.   We agree with Charlton.

     To be eligible for relief under section 6015(c), the

individual seeking relief must no longer be married to, or must


     3
      (...continued)
                            member of the same household as the
                            individual with whom such joint
                            return was filed at any time during
                            the 12-month period ending on the
                            date such election is filed.

                            (ii) Certain taxpayers ineligible
                       to elect.--If the Secretary demonstrates
                       that assets were transferred between
                       individuals filing a joint return as
                       part of a fraudulent scheme by such
                       individuals, an election under this
                       subsection by either individual shall be
                       invalid (and section 6013(d)(3) shall
                       apply to the joint return).

               (B) Time for election.--An election under
          this subsection for any taxable year shall be made
          not later than 2 years after the date on which the
          Secretary has begun collection activities with
          respect to the individual making the election.

               (C) Election not valid with respect to
          certain deficiencies.--If the Secretary
          demonstrates that an individual making an election
          under this subsection had actual knowledge, at the
          time such individual signed the return, of any
          item giving rise to a deficiency (or portion
          thereof) which is not allocable to such individual
          under subjection (d), such election shall not
          apply to such deficiency (or portion). This
          subparagraph shall not apply where the individual
          with actual knowledge establishes that such
          individual signed the return under duress.
                                -15-

be legally separated from, the individual with whom he or she

filed the joint return and must have elected the applicability of

section 6015(c) not later than 2 years after the date on which

collection activity began.    See sec. 6015(c)(3).

       An electing spouse bears the burden of proving how much of

any deficiency is allocable to him or her.    See sec. 6015(c)(2).

An election is not valid if respondent shows that the individual

making the election had actual knowledge when signing the return

of any “item” giving rise to a deficiency (or portion thereof)

which is not allocable to the electing individual.     See sec.

6015(c)(3)(C).    The only Medi-Task item causing a deficiency in

this case is omitted income.

       We have concluded that Charlton should have known of the

omitted income because he knew of and had access to correct

information about Medi-Task.    See par. C-2, above.   However, that

does not mean that he actually knew of the Medi-Task omitted

income.    Charlton did not check Medi-Task’s bank records against

the lists of Medi-Task revenue that Hawthorne prepared and gave

him.    The lists Hawthorne gave Charlton are not in the record.

Charlton testified that he did not know of the omitted income.

We have no reason not to believe him.    We conclude that

respondent has not shown that Charlton had actual knowledge of

the item causing the deficiency, and that Charlton qualifies for
                                -16-

relief under section 6015(c).   Thus, the procedures in section

6015(d) to allocate items between Hawthorne and Charlton apply.4


     4
         Sec. 6015(d) provides in part:

     SEC. 6015(d). Allocation of Deficiency.--For purposes
     of subsection (c)--

           (1) In general.--The portion of any deficiency on
           a joint return allocated to an individual shall be
           the amount which bears the same ratio to such
           deficiency as the net amount of items taken into
           account in computing the deficiency and allocable
           to the individual under paragraph (3) bears to the
           net amount of all items taken into account in
           computing the deficiency.

           (2) Separate treatment of certain items.--If a
           deficiency (or portion thereof) is attributable to
           –-

                (A)   the disallowance of a credit; or

                (B) any tax (other than tax imposed by
                section 1 or 55) required to be included with
                the joint return,

     and such item is allocated to one individual under
     paragraph (3), such deficiency (or portion) shall be
     allocated to such individual. Any such item shall not
     be taken into account under paragraph (1).

           (3) Allocation of items giving rise to the
           deficiency. For purposes of this subsection-–

                (A) In general. Except as provided in
                paragraphs (4) and (5), any item giving rise
                to a deficiency on a joint return shall be
                allocated to individuals filing the return in
                the same manner as it would have been
                allocated if the individuals had filed
                separate returns for the taxable year.

                (B) Exception where other spouse benefits.
                Under rules prescribed by the Secretary, an
                                                    (continued...)
                                 -17-

     For purposes of section 6015(c), an item giving rise to a

deficiency on a joint return is generally allocated as if the

individuals had filed separate returns.    See sec. 6015(d)(3)(A).

     Respondent contends that the parties should perform the

computations under section 6015(d) as part of the Rule 155

computations.   Neither Charlton nor Hawthorne objects to using

that procedure.    We agree with respondent, and we will so order.

E.   Whether the Tax Court Has Jurisdiction To Review a
     Taxpayer’s Request for Equitable Relief Under Section
     6015(f)

     Respondent contends that we lack jurisdiction to decide

whether the Commissioner properly denied relief to a taxpayer

under section 6015(f).    We disagree, for reasons stated in Butler

v. Commissioner, 114 T.C. __, __ (2000) (slip op. at 18-26).

     Hawthorne and respondent have apparently suspended any

activity relating to Hawthorne’s claim under section 6015(f)

while this case is pending.    If the Secretary denies her



     4
      (...continued)
               item otherwise allocable to an individual
               under subparagraph (A) shall be allocated to
               the other individual filing the joint return
               to the extent the item gave rise to a tax
               benefit on the joint return to the other
               individual.

                  (C) Exception for fraud. The Secretary may
                  provide for an allocation of any item in a
                  manner not prescribed by subparagraph (A) if
                  the Secretary establishes that such
                  allocation is appropriate due to fraud of one
                  or both individuals.
                                 -18-

application for relief under section 6015(f), Hawthorne may file

a motion as part of this docketed case to seek our review of the

Secretary’s denial within a time period to be provided by order

of this Court.   We will delay entry of decision until Hawthorne

and respondent report the status of the Secretary’s action under

section 6015(f).

     To reflect the foregoing,


                                             Appropriate orders

                                        will be issued.
