                        T.C. Memo. 2010-109



                      UNITED STATES TAX COURT



        THEODORE M. AND JACQUELINE GREEN, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 8247-08.                Filed May 17, 2010.



     Theodore M. Green and Jacqueline Green, pro sese.

     Michael Park, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     HAINES, Judge:   Theodore M. Green (Mr. Green) and Jacqueline

Green (Ms. Green) petitioned the Court for redetermination of the

following deficiencies in Federal income tax and penalties:
                                 - 2 -

                                              Penalty
     Year           Deficiency               Sec. 6662

     2004            $3,383                     $677
     2005             7,188                    1,438

In his answer, respondent further asserted that petitioners’

underpayments of tax for both 2004 and 2005 were attributable to

fraud under section 6663.1

     The issues for decision after concessions2 are:   (1) Whether

petitioners may deduct from income for 2004 as a net operating

loss (NOL) carryforward $8,098 relating to a $166,013 damage

award judgment that Ms. Green never received and that has now

been discharged in bankruptcy; (2) whether Social Security

disability benefits Ms. Green received in 2004 should be treated

as nontaxable worker’s compensation benefits; (3) whether

petitioners are entitled to a long-term capital loss carryover of

$3,000 for 2004; (4) whether petitioners failed to report pension

income of $7,978 for 2004; (5) whether petitioners are entitled

to deductions on Schedule A, Itemized Deductions, for medical

expenses of $53,888 and $102,242 for 2004 and 2005, respectively;

(6) whether petitioners are liable for fraud penalties under



     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended, and all Rule references
are to the Tax Court Rules of Practice and Procedure. Amounts
are rounded to the nearest dollar.
     2
      Respondent concedes that petitioners are entitled to
medical expenses of $355 and $4,347 for 2004 and 2005,
respectively.
                                 - 3 -

section 6663 for 2004 and 2005; and (7) whether petitioners are

liable for accuracy-related penalties under section 6662(a) for

2004 and 2005.   For all purposes hereafter, the term “years at

issue” shall refer to 2004 and 2005.

                            FINDINGS OF FACT

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

The stipulation of facts and the supplemental stipulation of

facts, together with the attached exhibits, are incorporated

herein by this reference.    At the time petitioners filed their

petition, they resided in California.

     Petitioners are husband and wife.    From 1985 to September

19, 2005, Mr. Green worked as a tax service representative and as

a tax auditor for respondent.

I.   Income From Default Judgment, Social Security Disability
     Benefits, and Pensions

     A.   Net Operating Loss Carryforward and Long-Term Capital
          Loss

     Before November 1989 Ms. Green worked on a General Motors

Corp. (GM) assembly line.    On November 12, 1989, Ms. Green was

injured at a grocery store when she was hit by a shopping cart.

Her injuries were apparently so severe that she was unable to

continue to work on the assembly line.    On November 7, 1990, Ms.

Green filed a lawsuit for personal injury damages against the

individual who hit her with the shopping cart, and on November
                               - 4 -

12, 1996, Ms. Green obtained a $166,013 default judgment against

that individual.

     On March 14, 1997, in a bankruptcy proceeding, the person

who hit Ms. Green with the shopping cart was discharged of

liability to pay the $166,013 default judgment, and petitioners

never collected the damages.   Petitioners never included any

portion of the $166,013 judgment in taxable income, and the

record does not establish that petitioners had any tax basis in

the uncollected judgment.

     On their 1997 joint individual income tax return petitioners

claimed an $11,068 casualty loss deduction relating to the

$166,013 uncollected judgment discharged in bankruptcy.

Petitioners attached to their 1997 tax return a statement that

they intended to deduct the balance of the $154,946 uncollected

judgment over the course of the next 15 years--$11,068 in each

year--as a loss carryforward under section 172.

     On their 2004 joint individual income tax return petitioners

claimed an NOL carryforward of $8,098 related to the uncollected

judgment.   Petitioners also claimed a long-term capital loss of

$3,000, which petitioners considered to represent a portion of

the uncollected judgment.3


     3
      Petitioners did not attach a Schedule D, Capital Gains and
Losses, to their 2004 return. On Aug. 3, 2005, respondent
received petitioners’ Schedule D, on which they claimed a long-
term capital loss of $3,000. Petitioners do not account for why
                                                   (continued...)
                                 - 5 -

     B.     Social Security Disability Benefits

     After sustaining injuries from the shopping cart in November

1989, Ms. Green worked for GM as a decal assembler.     On August

27, 1991, Ms. Green was involved in an industrial accident at a

GM plant.     Her injuries required surgery and left her unable to

work.     On August 6, 1992, Ms. Green filed a claim for Social

Security disability benefits at the order of GM, and on December

17, 1993, Ms. Green began to receive Social Security disability

benefits.

     In 2004 Ms. Green received Social Security disability

benefits of $13,495.     On their 2004 return petitioners reported

the $13,495 but did not report any amount of the $13,495 as

taxable income, on the grounds that the benefits were excludable

from income under section 104.

     C.     Pension Income

     For 2004 the State of California filed a Form 1099-R,

Distributions from Pensions, Annuities, Retirement or Profit-

Sharing Plans, IRAs, Insurance Contracts, etc., with the IRS that

reported Mr. Green as having received pension income of $1,578.

Petitioners reported Mr. Green’s pension income as taxable income



     3
      (...continued)
the combined amount of the net operating loss (NOL) carryforward
and the long-term capital loss reported on their 2004 return is
$30 higher than the NOL carryforward of $11,068 reported on their
1997 return or--as discussed below--on each of their 2000, 2001,
and 2003 returns.
                                 - 6 -

on their 2004 return.    Also for 2004, the GM Hourly-Rate Pension

Trust filed a Form 1099-R with the IRS that reported Ms. Green as

having received pension income of $8,778, of which $7,979 was

taxable.    Petitioners did not include any amount of Ms. Green’s

pension income as taxable on their 2004 return.

     D.    Prior Litigation

     On their 2000 and 2001 joint individual income tax returns

petitioners claimed an NOL carryforward of $11,068 relating to

the uncollected judgment.     Petitioners also reported Social

Security disability benefits received by Ms. Green of $12,258 and

$12,708, for 2000 and 2001, respectively, but did not report any

amount as taxable income.

     The Internal Revenue Service (IRS) issued timely notices of

deficiency for 2000 and 2001, and petitioners filed petitions

with this Court.4   In a consolidated Tax Court opinion released

on March 9, 2006, Green v. Commissioner, T.C. Memo. 2006-39

(Green I), affd. 262 Fed. Appx. 790 (9th Cir. 2007), we held that

petitioners were not entitled to deduct the NOL carryforward as a

loss under section 165 and that Ms. Green’s Social Security

disability benefits were taxable for both 2000 and 2001.

Petitioners appealed our decision in Green I to the U.S. Court of

Appeals for the Ninth Circuit.     The Court of Appeals affirmed our



     4
      The cases for 2000 and 2001 became docket Nos. 2475-04 and
4970-05, respectively.
                                - 7 -

decision in an unpublished opinion issued on December 28, 2007.

Mr. Green testified at trial that he appealed the decision of the

Court of Appeals to the U.S. Supreme Court.     The record does not

indicate whether petitioners filed a writ of certiorari with the

Supreme Court, but it is clear that the Supreme Court did not

grant certiorari in petitioners’ case.

      On their 2003 joint individual income tax return petitioners

again claimed an NOL carryforward of $11,068 and failed to report

any of Ms. Green’s Social Security disability benefits as taxable

income.    The IRS issued a notice of deficiency, and petitioners

filed a petition.5   In an opinion released on August 7, 2007,

Green v. Commissioner, T.C. Memo. 2007-217 (Green II), we held

that petitioners were not entitled to deduct the NOL carryforward

and that Ms. Green’s Social Security disability benefits were

taxable.    Petitioners did not appeal Green II.

II.   Schedule A Medical Expenses

      Petitioners claimed unreimbursed medical expenses of $1,525

on Schedule A of their 2004 return.     Petitioners claimed

unreimbursed medical expenses of $38,367 on Schedule A of their

2005 return.    At the time of trial petitioners claimed medical

expenses for 2004 and 2005 of $53,888 and $102,242,




      5
       The case for 2003 became docket No. 5216-06.
                                 - 8 -

respectively.6    These sums included expenditures related to

transportation expenses, housekeeping expenses, gas and electric

bills, and accrued but unpaid general medical expenses.

     A.     Transportation Expenses

     After her accident at the GM plant in 1991 Ms. Green was

unable to drive an automobile.    For 2004 and 2005 petitioners

hired Christopher McGrath (Mr. McGrath) to be Ms. Green’s

personal driver.    Mr. McGrath drove Ms. Green to her numerous

doctor’s appointments, the grocery store, and to have her hair

and nails done.    Mr. McGrath did not possess any medical

training, and he drove a Honda Civic that was not modified in any

way to transport a physically disabled individual.    Neither Mr.

McGrath nor petitioners kept a log or records showing the dates

and times Mr. McGrath drove Ms. Green to her medical

appointments.

     Ms. Green paid only a portion of Mr. McGrath’s service fees.

The balance of Mr. McGrath’s invoices for transporting Ms. Green

was billed to Sedgwick Management Co. (Sedgwick), a car service

provider.    In 2004 and 2005 Ms. Green paid Mr. McGrath $135 and




     6
      At the time petitioners filed their 2004 and 2005 returns,
they believed that GM would pay many of their accrued medical
expenses. As GM failed to pay, petitioners at trial claimed
medical expenses in addition to those reported on their returns.
                                 - 9 -

$2,365, respectively, while Mr. McGrath billed Sedgwick $756 and

$13,235, respectively.7

     B.   Housekeeping Expenses

     Ms. Green’s injuries also prevented her from performing

household chores.   For 2004 and 2005 petitioners hired two

housekeepers to clean the house, cook the meals, and serve Ms.

Green at petitioners’ home.   Petitioners paid these housekeepers

$17,770 and $16,380 in 2004 and 2005, respectively.

     C.   Gas and Electric Bills

     For 2004 petitioners paid $1,566 and $2,179 for their gas

and electric bills, respectively.    For 2005 petitioners paid $585

and $1,950 for their gas and electric bills, respectively.

     D.   Method of Accounting

     On their 1985 joint income tax return petitioners reported

that they operated a small tax service business.   On their

Schedule C, Profit or Loss From Business, attached to their 1985

return, petitioners elected to report their Schedule C income and

expenses on an accrual basis.    For 2004 and 2005 petitioners were

not engaged in a Schedule C business.




     7
      Sedgwick failed to pay Mr. McGrath’s invoices in full for
the years at issue, and Mr. McGrath currently has liens against
Sedgwick for the unpaid portions of his service fees for
transporting Ms. Green.
                              - 10 -

III. Present Litigation

     On January 17, 2008, respondent sent petitioners a notice of

deficiency for the years at issue.     On April 7, 2008, petitioners

filed a petition with this Court.    On June 11, 2008, respondent

filed an answer which alleged that petitioners were subject to

fraud penalties for the years at issue under section 6663.    On

September 2, 2008, petitioners filed a reply to respondent’s

answer, which denied the allegations of fraud.    On May 14, 2009,

respondent filed an amendment to answer which asserted collateral

estoppel as an affirmative defense to whether petitioners are

entitled to exclude their Social Security disability benefits

from income under section 104 and deduct an NOL carryforward

under section 165 for 2004.   A trial was held on May 14, 2009, in

Los Angeles, California.   At trial petitioners argued that they

were entitled to deduct medical expenses for 2004 and 2005 in

excess of those listed on their respective returns.

                              OPINION

I.   Burden of Proof

     Respondent’s determinations in the notice of deficiency are

presumed correct, and petitioners bear the burden of proving that

respondent’s determinations are incorrect.8    See Rule 142(a)(1).


     8
      Petitioners do not argue that the burden of proof shifts
to respondent pursuant to sec. 7491(a), nor have they shown that
the threshold requirements of sec. 7491(a) have been met for any
of the determinations at issue.
                              - 11 -

Respondent has the burden of proof by clear and convincing

evidence with respect to his determination of fraud.   See Rule

142(b).

II.   Net Operating Loss Carryforward and Social Security Benefits

      Petitioners argue that they are entitled to deduct under

section 165 an NOL carryforward of $8,098 for 2004 related to the

uncollected judgment of $166,013 which Ms. Green was awarded as a

result of her shopping cart accident.   Petitioners also argue

that the Social Security disability benefits of $13,495 that Ms.

Green received in 2004 constitute worker’s compensation under

section 104 and are thus not includable in gross income.

Respondent contends that petitioners are precluded under the

doctrine of collateral estoppel from relitigating these issues.

We agree with respondent.

      Collateral estoppel exists for the “dual purpose of

protecting litigants from the burden of relitigating an identical

issue and of promoting judicial economy by preventing unnecessary

or redundant litigation.”   Meier v. Commissioner, 91 T.C. 273,

282 (1988); see also Montana v. United States, 440 U.S. 147, 153-

154 (1979); Parklane Hosiery Co. v. Shore, 439 U.S. 322, 326

(1979).   In general, the doctrine of collateral estoppel

forecloses relitigation of issues actually litigated and

necessarily decided in a prior suit.    Parklane Hosiery Co. v.

Shore, supra at 326 n.5; Meier v. Commissioner, supra at 282;
                              - 12 -

Peck v. Commissioner, 90 T.C. 162, 166 (1988), affd. 904 F.2d 525

(9th Cir. 1990).

     This Court, expanding upon three factors identified by the

Supreme Court in Montana v. United States, supra at 155, has set

forth five prerequisites necessary for the application in factual

contexts of collateral estoppel:

          (1) The issue in the second suit must be identical
     in all respects with the one decided in the first suit.

          (2) There must be a final judgment rendered by a
     court of competent jurisdiction.

          (3) Collateral estoppel may be invoked against
     parties and their privies to the prior judgment.

          (4) The parties must actually have litigated the
     issues and the resolution of these issues must have
     been essential to the prior decision.

          (5) The controlling facts and applicable legal
     rules must remain unchanged from those in the prior
     litigation.

     [Peck v. Commissioner, supra at 166-167; citations
     omitted.]

     All five requirements are satisfied in the instant case:

(1) The issues of whether petitioners are entitled to exclude

their Social Security disability benefits from income and deduct

an NOL carryforward are identical to the issues litigated in

Green I and Green II; (2) final judgment was rendered in both

cases;   (3) the parties in Green I and Green II are identical to

those in the instant case; (4) the parties litigated the issues

and the resolution of those issues was essential to the decision
                                - 13 -

in both Green I and Green II; and (5) the controlling facts and

applicable legal rules concerning the issues in the instant case

are unchanged from those in Green I and Green II.

     Accordingly, the doctrine of collateral estoppel applies,

and petitioners are precluded from relitigating the net operating

loss carryforward and Social Security benefits issues raised in

Green I and Green II.

III. Long-Term Capital Loss

     Section 1211 provides that in the case of noncorporate

taxpayers, capital losses are deductible only to the extent of

capital gains plus $3,000.     When capital losses exceed capital

gains by more than $3,000, the excess may be carried over to

later taxable years to reduce capital gains or a limited amount

of ordinary income.     Sec. 1212(b).    A long-term capital loss is

the loss from the sale or exchange of a capital asset held for

longer than 1 year.     Sec. 1222(4).

     Mr. Green testified at trial that the $3,000 capital loss

was not from the sale of a capital asset but rather constituted a

recharacterization of a portion of the $11,068 NOL carryforward

that respondent had previously disallowed.      The record does not

indicate that the loss is related to the sale of a capital asset.

Accordingly, we sustain respondent’s determinations regarding the

long-term capital loss.
                              - 14 -

IV.   Pension Income

      Petitioners argue that Ms. Green’s $8,778 of pension income

for 2004 constituted worker’s compensation.    Petitioners claim

that GM issued the Form 1099-R out of vindictiveness against

petitioners and that the proceeds had been categorized as

worker’s compensation in prior years.

      Petitioners offered no evidence that Ms. Green’s pension

income was payment of worker’s compensation.    At trial Mr. Green

testified that GM was either “ignorant or malicious” in issuing

the Form 1099-R but the record is devoid of anything to

corroborate this claim.   Accordingly, we sustain respondent’s

determination regarding petitioners’ pension income.

V. Deductions for Medical Expenses

      Petitioners argued at trial that they incurred medical

expenses of $54,888 and $102,242 for 2004 and 2005, respectively.

These consisted of the following amounts:   (1) Medical expenses

conceded by respondent of $355 and $4,347 for 2004 and 2005,

respectively; (2) transportation costs of $891 and $15,600 for

2004 and 2005, respectively; (3) housekeeper expenses of $17,770

and $16,380 for 2004 and 2005, respectively; (4) gas and electric

expenses of $3,755 and $2,537 for 2004 and 2005, respectively;

and (5) accrued but unpaid medical expenses of $31,127 and

$63,381 for 2004 and 2005, respectively.
                                - 15 -

     Section 213(a) allows for the deduction of paid expenses

“not compensated for by insurance or otherwise, for medical care

of the taxpayer, his spouse, or a dependent * * * to the extent

that such expenses exceed 7.5 percent of adjusted gross income.”

We have characterized section 213 as carving out “a limited

exception” to the general rule in section 262 that prohibits the

deduction of personal, living, or family expenses.     Jacobs v.

Commissioner, 62 T.C. 813, 818 (1974).     The deductibility of the

expenses at issue hinges on whether they were paid for

petitioner’s medical care.     If so, they are deductible medical

expenses under section 213.     If not, they are nondeductible

personal expenses under section 262.

     The term “medical care” includes amounts paid “for the

diagnosis, cure, mitigation, treatment, or prevention of disease,

or for the purpose of affecting any structure or function of the

body”.    Sec. 213(d)(1)(A).   The regulations provide that

“Deductions for expenditures for medical care allowable under

section 213 will be confined strictly to expenses incurred

primarily for the prevention or alleviation of a physical or

mental defect or illness.”     Sec. 1.213-1(e)(1)(ii), Income Tax

Regs.    Furthermore, to substantiate medical and dental expenses

under section 213, the taxpayer must furnish the name and address

of each person to whom payment was made and the amount and date

of each payment.    See sec. 1.213-1(h), Income Tax Regs.
                                - 16 -

     As discussed below, petitioners have failed to meet their

burden of substantiating any of their claimed medical expenses.

Therefore, no deductions for medical expenses will be allowed

beyond those respondent has already conceded.

     A.   Transportation Costs

     Petitioners claim that the amounts charged by Mr. McGrath

for transporting Ms. Green in 2004 and 2005 constitute deductible

medical expenses.   First, petitioners are not entitled to claim

the amounts billed to Sedgwick as medical expenses.9      Petitioners

have presented no evidence to show that they were in any way

associated with the payments made by Sedgwick to Mr. McGrath, and

Sedgwick has failed to fully pay Mr. McGrath for the amounts

billed.

     With regard to petitioners’ out-of-pocket expenses,

transportation costs related to personal errands are

nondeductible personal expenses.    Sec. 262; Haines v.

Commissioner, 71 T.C. 644, 646 (1979).    Although respondent

concedes that transportation costs associated with driving Ms.

Green to doctor’s appointments may be deductible medical

expenses, petitioners have failed to provide any records to

substantiate the amounts of those expenses or the dates and times

those expenses were incurred.    See sec. 1.213-1(h), Income Tax

     9
      Petitioners paid Mr. McGrath $135 in 2004 and $2,365 in
2005 for his services as a driver. Mr. McGrath billed Sedgwick
$756 in 2004 and $13,235 in 2005 for transporting Ms. Green.
                                - 17 -

Regs.     The record indicates that a large number, if not the

majority, of Ms. Green’s trips with Mr. McGrath were to run

personal errands.10    Therefore, we find that petitioners have not

met their burden to show that their travel costs constitute

medical expenses.

     As a general rule, if the trial record provides sufficient

evidence that the taxpayer has incurred a deductible expense, but

the taxpayer is unable to substantiate adequately the precise

amount of the deduction to which he or she is otherwise entitled,

the Court may estimate the amount of the deductible expense and

allow the deduction to that extent.      Cohan v. Commissioner, 39

F.2d 540, 543-544 (2d Cir. 1930); Vanicek v. Commissioner, 85

T.C. 731, 742-743 (1985); Sanford v. Commissioner, 50 T.C. 823,

827-828 (1968), affd. per curiam 412 F.2d 201 (2d Cir. 1969);

sec. 1.274-5T(a), Temporary Income Tax Regs., 50 Fed. Reg. 46014

(Nov. 6, 1985).     In these instances, the Court is permitted to

make as close an approximation of the allowable expense as it

can, bearing heavily against the taxpayer whose inexactitude is

of his or her own making.     Cohan v. Commissioner, supra at 544.

However, in order for the Court to estimate the amount of an

expense, the Court must have some basis upon which an estimate

may be made.     Vanicek v. Commissioner, supra at 742-743.   Without

     10
      Mr. McGrath testified that he drove Ms. Green to her
doctor’s appointments as well as to run her personal errands such
as grocery shopping, hair styling, and manicures.
                                - 18 -

such a basis, any allowance would amount to unguided largesse.

Williams v. United States, 245 F.2d 559, 560-561 (5th Cir. 1957).

     The record provides no satisfactory basis for estimating the

amounts of petitioners’ transportation costs that may have been

used for trips to the doctor’s office as opposed to the hair

stylist.    Consequently, the Court will not apply the Cohan rule

to estimate the amounts of petitioners’ transportation costs that

may constitute medical expenses.

     B.     Housekeeper Costs

     Petitioners claim that the amounts they paid to their

housekeepers in 2004 and 2005 constitute medical expenses.       The

housekeepers did not render medical care but were required

because Ms. Green, according to Mr. Green’s testimony at trial,

“maintains a complete, meticulous, excellent, clean” home, and

“does not like filth in any way, shape or fashion.”      Although

petitioners’ zeal for cleanliness may have resulted in a

psychological benefit to Ms. Green, it was not “for the

diagnosis, cure, mitigation, treatment, or prevention of disease,

or for the purpose of affecting any structure or function of the

body”.    See sec. 213(d)(1)(A).   Expenses incurred which are

merely beneficial to the general health of an individual are not

deductible.    Gardner v. Commissioner, T.C. Memo. 1983-541; sec.

1.213-1(e)(1)(ii), Income Tax Regs.      Moreover, the salary and

cost of room and board for housekeepers hired on the advice of a
                               - 19 -

doctor are not deductible medical expenses.    Borgmann v.

Commissioner, 438 F.2d 1211 (9th Cir. 1971), affg. T.C. Memo.

1969-129.    Accordingly, petitioners have failed to show that

their payments to their housekeepers constitute medical expenses.

     C.     Gas and Electric Bills

     Petitioners seek to deduct their gas and electric bills for

the years at issue as medical expenses.    In general, the cost of

maintaining a household, including amounts paid for utilities,

are personal expenses which are not deductible.    Sec. 1.262-

1(b)(3), Income Tax Regs.    Petitioners testified at trial that

they paid some of their gas and electric bills in order to power

a heating pool and several devices that were therapeutic for Ms.

Green.    Where a living expense is used primarily for the

alleviation of an ailment, a medical deduction is allowable to

the extent of the excess cost attributable to the medical

purpose.    Gardner v. Commissioner, supra; see also Randolph v.

Commissioner, 67 T.C. 481 (1976); Harris v. Commissioner, 46 T.C.

672 (1966).    Petitioners have failed to demonstrate what portion

of their gas and electric bills was used to power devices

employed primarily for the alleviation of Ms. Green’s medical

problems and whether their utility costs were higher as a result

of the devices.    Therefore, we find that their gas and electric

bills do not constitute medical expenses.
                                - 20 -

      D.    Accrued but Unpaid Medical Expenses

      At trial petitioners claimed a balance of medical expense

deductions of $31,127 and $63,381 for 2004 and 2005,

respectively.     Petitioners argue that these expenses are accrued

medical expenses that have not yet been paid.     Petitioners

further argue that they were accrual basis taxpayers for the

years at issue and base this assertion on their election to treat

their Schedule C business on an accrual basis on their 1985

return.

      Petitioners’ method of accounting is irrelevant.    Medical

expenses may be deducted only in the year of actual payment.

Sec. 1.213-1(a)(1), Income Tax Regs.     As far as the record is

concerned, petitioners’ allegedly accrued but unpaid medical

expenses appear to have been conjured out of thin air.

Petitioners have failed to substantiate any of their medical

expenses not otherwise conceded by respondent, and the Court is

left with no basis upon which to estimate them.     Accordingly,

other than those respondent has conceded, we allow none of

petitioners’ claimed medical expense deductions for the years at

issue.

VI.   Fraud Penalty

      In order to show fraud under section 6663, respondent must

prove:     (1) An underpayment exists; and (2) petitioners intended

to evade taxes known to be owing by conduct intended to conceal,
                                 - 21 -

mislead, or otherwise prevent the collection of taxes.     See Parks

v. Commissioner, 94 T.C. 654, 660-661 (1990).

     A.   Underpayment of Tax

     Respondent must first show by clear and convincing evidence

that petitioners had an underpayment of tax in each of the years

at issue.   As discussed above, respondent has shown that

petitioners received income from Social Security disability

benefits and pensions on which they failed to pay tax for 2004.

Respondent has also shown that petitioners claimed deductions for

medical expenses, NOL carryforwards, and long-term capital losses

for 2004, and medical expenses for 2005, to which they were not

entitled and which resulted in underpayments of tax.     Therefore,

respondent has satisfied his burden of proof on this issue for

both 2004 and 2005.

     B.   Fraudulent Intent

     Because direct evidence of fraud is rarely available, fraud

may be proved by circumstantial evidence and reasonable

inferences from the facts.      Petzoldt v. Commissioner, 92 T.C.

661, 699 (1989).   Courts have developed a nonexclusive list of

factors, or “badges of fraud”, that demonstrate fraudulent

intent.   Niedringhaus v. Commissioner, 99 T.C. 202, 211 (1992).

These badges of fraud include:     (1) Understating income, (2)

maintaining inadequate records, (3) implausible or inconsistent

explanations of behavior, (4) concealment of income or assets,
                               - 22 -

(5) failing to cooperate with tax authorities, (6) engaging in

illegal activities, (7) an intent to mislead which may be

inferred from a pattern of conduct, (8) lack of credibility of

the taxpayer’s testimony, (9) filing false documents, (10)

failing to file tax returns, and (11) dealing in cash.    Id.; see

also Spies v. United States, 317 U.S. 492, 499 (1943); Morse v.

Commissioner, 419 F.3d 829, 832 (8th Cir. 2005), affg. T.C. Memo.

2003-332; Recklitis v. Commissioner, 91 T.C. 874, 910 (1988).

Although no single factor is necessarily sufficient to establish

fraud, the combination of a number of factors constitutes

persuasive evidence.    Niedringhaus v. Commissioner, supra at 211.

Respondent must prove fraud for each year at issue.    See id. at

210; Ferguson v. Commissioner, T.C. Memo. 2004-90.    Petitioners’

behavior with respect to their income may be evaluated in the

light of these factors, as follows.

            1.   Understated Income

       Respondent has shown that petitioners understated their

income for 2004.    This factor is mitigated by petitioners’

inclusion of their Social Security disability benefits on their

2004 return as proceeds excluded from taxable income by section

104.    Respondent argues that petitioners had reason to know at

the time they filed their 2004 return that their position

regarding the benefits was incorrect because respondent had

already issued notices of deficiency determining that the
                               - 23 -

benefits were taxable for 2001 and 2002.     At the time petitioners

filed their 2004 return, however, no court had issued a decision

regarding the issue.

     Petitioners also omitted pension income on their 2004

return.   This factor militates in favor of a finding of fraud.

            2.   Inadequate Records

     The record indicates that petitioners did not keep adequate

records for either 2004 or 2005.      They failed to substantiate the

bulk of their medical expense deductions for each of the years at

issue.

            3.   Implausible Behavior

     Petitioners believed, at the time they filed their 2004

return, that the taxation of their Social Security disability

benefits and the allowance of their NOL carryforward presented

valid legal disputes to be decided by the courts.     Although Mr.

Green, a former IRS agent, placed too much faith in his tax

analytical skills, his behavior with regard to tax reporting has

been consistently plausible:   petitioners first notified the IRS

in 1997 of their attempt to claim a casualty loss deduction and

kept the theory alive through petitions and appeals as long as

possible.    Less easy to countenance are the large claimed medical

expense deductions.    However, both petitioners credibly testified

to the extent of their medical problems and have maintained a

consistent position reflecting their belief that they were
                                - 24 -

entitled to medical expense deductions.     Petitioners also had a

consistent, if flawed, rationale for not reporting Ms. Green’s GM

pension income and for reporting a long-term capital loss for

2004.

             4.   Concealment of Income

        Petitioners did not actively conceal income or assets.   The

Social Security disability benefits they received were listed on

their 2004 return.     Petitioners did not report Ms. Green’s GM

pension income, but they also made no attempt to conceal it when

their return came under audit.

             5.   Compliance With Tax Officials

        Petitioners fully complied with the audit process and all

court proceedings.

             6.   Illegal Activities

        Petitioners never engaged in illegal activities.

             7.   Pattern of Misconduct With Intent To Mislead

        Petitioners did not engage in a pattern of conduct to

mislead tax authorities.     As previously stated, petitioners

honestly believed they were entitled to exclude their Social

Security disability benefits and the GM pension from income and

deduct the uncollected judgment resulting from the shopping cart

incident.     Petitioners were also under the impression that they

were entitled to additional medical expense deductions for

transportation costs, housekeeping costs, and gas and electric
                                - 25 -

bills for the years at issue.     The record does not indicate that

petitioners attempted to deduct large and unsubstantiated medical

expenses on their returns for prior years.

          8.    Credibility of Testimony

     Petitioners’ testimony was generally credible with regard to

their intent.

          9.    False Documents

     Petitioners never intentionally filed a false document.

          10.   Failing to File Tax Returns

     Petitioners timely filed their 2004 and 2005 returns.

          11.   Dealing in Cash

     Petitioners did not deal in cash.

     As a result of the paucity of badges of fraud, we find that

respondent has failed to show by clear and convincing evidence

that petitioners filed their 2004 and 2005 returns with the

intent to evade tax.

VII. Accuracy-Related Penalty

     Section 6662(a) and (b)(2) imposes an accuracy-related

penalty upon any underpayment of tax resulting from a substantial

understatement of income tax.     The penalty is equal to 20 percent

of the portion of any underpayment attributable to a substantial

understatement of income tax.     Id.    The term “substantial

understatement” is defined as exceeding the greater of:      (1) 10

percent of the tax required to be shown on the return for the
                               - 26 -

taxable year, or (2) $5,000.   Sec. 6662(d)(1)(A).     Section

6662(a) and (b)(1) also imposes a penalty equal to 20 percent of

the amount of an underpayment attributable to negligence or

disregard of rules or regulations.      Negligence includes any

failure to make a reasonable attempt to comply with the

provisions of the Internal Revenue Code.      Sec. 6662(c).

     We hold that petitioners are liable for the penalty for

negligence in 2004 and substantial understatement of income tax

in 2005.   Petitioners’ failure to produce records substantiating

their medical expenses, NOL deductions, and Social Security

disability benefit exclusions supports the imposition of the

accuracy-related penalty for negligence for 2004.      Petitioners’

understatement of income tax as reflected in the notice of

deficiency is greater than $5,000 and 10 percent of the tax

required to be shown on the return in 2005.      Thus, respondent has

met his burden of production under section 7491(c).

     An accuracy-related penalty is not imposed on any portion of

the underpayment as to which the taxpayer acted with reasonable

cause and in good faith.   Sec. 6664(c)(1).     The taxpayer bears

the burden of proof with regard to those issues.      Higbee v.

Commissioner, 116 T.C. 438, 446 (2001).      Petitioners have failed

to show reasonable cause, substantial authority, or any other

basis for reducing the penalties.    Mr. Green was a tax service

representative with the IRS for over a decade.      With this
                              - 27 -

background, he had a wider range of knowledge of tax matters than

do members of the general public.   See Kendrix v. Commissioner,

T.C. Memo. 2006-9.   The Court sympathizes with petitioners for

the injuries that have afflicted them over the years.

Unfortunately, given the dearth of evidence to substantiate

petitioners’ medical expenses, NOL deductions, and Social

Security disability benefit exclusions, we are unable to mitigate

the penalties.   Accordingly, we find petitioners liable for the

section 6662 penalty for 2004 and 2005 as commensurate with

respondent’s concessions and our holding.   See Higbee v.

Commissioner, supra at 446.

     In reaching our holdings herein, we have considered all

arguments made, and, to the extent not mentioned above, we

conclude they are moot, irrelevant, or without merit.

     To reflect the foregoing,


                                         Decision will be entered

                                    under Rule 155.
