                         T.C. Memo. 1998-202



                       UNITED STATES TAX COURT



         JOE T. KIEFFER AND LINDA R. KIEFFER, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 9404-96.                         Filed June 2, 1998.


     Joe T. Kieffer and Linda R. Kieffer, pro sese.

     Gregory M. Hahn and Christal W. Hillstead, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION

     DEAN, Special Trial Judge:    This case was heard pursuant to

section 7443A(b)(3) and Rules 180, 181, and 182.1     Respondent

determined deficiencies in petitioners' Federal income taxes for

the taxable years 1993 and 1994 in the amounts of $1,873 and


     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable years in
issue. All Rule references are to the Tax Court Rules of
Practice and Procedure.
                                 - 2 -


$1,509, respectively and accuracy-related penalties in the

amounts of $375 and $302, respectively.

     The issues for decision are whether petitioners' income from

the sale of lumber by petitioner Joe T. Kieffer (petitioner) is

exempt from income tax and whether petitioners are liable for the

accuracy-related penalty under section 6662.   If we find that the

income from lumber sales is subject to income tax, the parties

agree that petitioners are entitled to trade and business expense

deductions in the amounts of $11,214 in 1993 and $6,954 in 1994,

and self-employment tax deductions in the amounts of $427 in 1993

and $265 in 1994.

     All of the facts are stipulated and are so found.     The

stipulation of facts and the attached exhibits are incorporated

herein by reference.   Petitioners resided in Fruitland,

Washington, at the time their petition was filed.

                            Background

     In 1993 and 1994 petitioners were and currently are enrolled

members of the Spokane Indian Tribe (tribe).   Petitioner was

self-employed in 1993 and 1994.    He harvested diseased timber on

the tribal reservation pursuant to a tribal permit allowing him

to conduct such activity.    Reservation land was and continues to

be land not allotted to individual Indians.

     Petitioner transported the timber he harvested on

reservation land to "his property" where it was cut into lumber.
                               - 3 -


The property where petitioner cut the timber into lumber was and

remains reservation land not allotted to an individual Indian.

The lumber petitioner produced was sold to Spokane Indian

Reservation Timber Products Enterprises (SIRTPE).   In 1993,

petitioner had lumber sales of $17,253 to SIRTPE and in 1994 his

sales to SIRTPE were in the amount of $10,699.   Petitioner

incurred lumber sales expenses of $11,214 in 1993 and $6,954 in

1994.

     On their joint individual Federal income tax returns filed

for 1993 and 1994, petitioners did not report income or expenses

from lumber sales.   Attached to the return for 1993 is a Form

1099-MISC reporting nonemployee compensation from SIRTPE bearing

the handwritten notation, "Indian Exempt".

                            Discussion

     Respondent takes the position that petitioners must report

as income receipts from lumber sales and are allowed to deduct

expenses associated with such sales for both years.

Petitioners argue that "income derived by an Indian from

activities which directly benefit the Tribe is tax-exempt."

Petitioners argue also that income derived by an Indian from a

"natural resource" on Indian reservation land is, by analogy to

section 7873, exempt from income tax.

     We start from the premise that every item of a person's

gross income is subject to Federal income tax, unless there is a
                                - 4 -


statute or some rule of law that exempts the person or the item

from gross income.    HCSC-Laundry v. United States, 450 U.S. 1, 5

(1981).   Tax exemptions, including those affecting native

peoples, are not granted by implication.   If Congress intends to

exempt certain income, it must do so expressly.    Earl v.

Commissioner, 78 T.C. 1014, 1017 (1982); Lazore v. Commissioner,

T.C. Memo. 1992-404, affd. in part and revd. in part 11 F.3d 1180

(3d Cir. 1993).

     It is well established that American Indians are subject to

Federal income taxation unless an exemption exists in the

language of a treaty or an Act of Congress.    Squire v. Capoeman,

351 U.S. 1, 6 (1956); United States v. Willie, 941 F.2d 1384,

1400 (10th Cir. 1991); Cross v. Commissioner, 83 T.C. 561, 564

(1984), affd. sub nom. Dillon v. United States, 792 F.2d 849 (9th

Cir. 1986).

     Petitioners do not point to any treaty provision which they

allege exempts their tribal lands from taxation and we are unable

to find such a provision.   See Northern Pac. Ry. Co. v. Wismer,

246 U.S. 283 (1918) (describes an "agreement" between the Spokane

Tribe of Indians, the Department of the Interior, and the

Department of War).   The only "Act of Congress" referred to by

petitioners is section 7873.

     Under section 7873, income derived by a member of an Indian

tribe "directly or through a qualified Indian entity" from a
                               - 5 -


"fishing rights-related activity of such tribe" is not subject to

income tax.   For purposes of section 7873, income derived from

"fishing rights-related activity" means income derived from

activity "directly related" to harvesting, processing,

transporting, or selling fish in the exercise of recognized

fishing rights of an Indian tribe.     Sec. 7873(b).   Petitioners'

income from lumber sales is not income derived from Indian

fishing-rights-related activity and is not exempt under the

statute.   See Warbus v. Commissioner, 110 T.C. ___ (1998).

     Petitioners' argument, however, is that the intent of

Congress, as expressed by the protection of Indian fishing-

rights-related activity under section 7873, "should also apply to

timber harvested and processed within the boundaries of the

Spokane Indian Reservation."   A similar issue has been addressed

and resolved contrary to petitioners' position.

     Petitioners' lumber sales income is, arguably, income

derived from Indian land, which under some circumstances is

exempt from income tax.   In Squire v. Capoeman, supra, it was

held that income from allotted lands upon which a patent2 had not

been issued is not subject to income tax.     The Court concluded

that a Federal income tax exemption was created by the Indian

General Allotment Act of 1887 (General Allotment Act), ch. 119,

     2
      The term "patent" as used here refers to an allotment
certificate. See Monson v. Simonson, 231 U.S. 341, 345-346
(1913).
                               - 6 -


24 Stat. 388, 25 U.S.C. sec. 331-358 (1998) for income that an

individual Indian allottee derives directly from the land held in

trust for him.   The Court reasoned that there existed a

congressional intent to exempt allotted lands from all charges

and encumbrances until after the fee interest was conveyed to the

individual allottee.   It held that income received by a

noncompetent3 Indian from the sale of standing timber logged off

of his own allotment was exempt from Federal income tax.

     In Fry v. United States, 557 F.2d 646 (9th Cir. 1977),

Indian taxpayers contracted with a non-Indian concern to cut

timber from unallotted lands of an Indian reservation.     The

taxpayers argued that their logging income should not be subject

to tax since the income that the tribe itself received from the

logging was not subject to tax, citing Squire v. Capoeman, supra,

and Stevens v. Commissioner, 452 F.2d 741 (9th Cir. 1971), affg.

in part, revg. in part 54 T.C. 351 (1970).   The opinion of the

Ninth Circuit Court of Appeals in the Fry case pointed out that

there was no treaty or statute that exempted the tribal lands in

question from Federal income taxation.   It also stated that, "In

both Squire and Stevens, the income which was held to be exempt


     3
      The trust under which the United States holds the allotted
lands makes the individual allottee "noncompetent" to alienate it
without permission of the United States. The term "noncompetent"
"does not denote mental incapacity." Stevens v. Commissioner,
452 F.2d 741, 742 n.1 (9th Cir. 1971), affg. in part, revg. in
part 52 T.C. 330 (1969).
                               - 7 -


to the allottee was from operations conducted on his own allotted

land."   Fry v. United States, supra at 648.   Another factor cited

by the court was the taxpayers' failure to show that their income

met the Squire test of being derived "directly" from the land as

opposed to being derived from a contract.

     Petitioners argue that, but for the fact that the taxpayers

in Fry v. United States, supra, did not earn their income

directly from the land as required by Squire v. Capoeman, supra,

the taxpayers would have prevailed.    Petitioners' argument was

addressed in United States v. Anderson, 625 F.2d 910 (9th Cir.

1980).   The issue there was whether the income a noncompetent

Indian derived from cattle ranching under a tribal license on

land held in trust by the United States for other Indians and for

the tribe was subject to Federal income taxation.    The court in

Anderson found that the rationale of the Squire v. Capoeman,

supra, case was:

     if an Indian's allotted land (or the income directly
     derived from it) was taxed, and the tax was not paid,
     the resulting tax lien on the land would make it
     impossible for him to receive the land free of
     'incumbrance' at the end of the trust period. * * * By
     contrast, 'taxation of the taxpayer's individual profit
     derived from his lease of tribal [or other allottees'
     trust] land cannot possibly represent a burden or
     encumbrance upon the tribe's [or other allottees']
     interest in such land.' Citing Holt v. Commissioner,
     364 F.2d 38, 41 (8th Cir. 1966), affg. 44 T.C. 686
     (1965). [United States v. Anderson, supra, at 914].

     The Court of Appeals for the Ninth Circuit held in Anderson

that the General Allotment Act provides no tax exemption for the
                                - 8 -


income a noncompetent Indian derives from other Indians' or his

tribe's trust land.    Accord Holt v. Commissioner, 44 T.C. 686

(1965), affd. 364 F.2d 38 (8th Cir. 1966).

     Contrary to the argument petitioners urge us to adopt,

"Policy alone cannot support a federal tax exemption in the

absence of express exemptive language in a statute or treaty."

United States v. Anderson, supra at 917.     Petitioners earned

income from logging pursuant to a tribal permit on trust land and

lumber sales to the tribe.    Petitioners were not allottees and

did not derive income from sales of lumber produced from timber

on their own allotted lands.    Petitioners' income from lumber

sales is not income derived from Indian fishing-rights-related

activity and is not income that is exempt under any treaty

provision.    Petitioners' lumber sales income is not exempt from

Federal income tax.

     Respondent determined that a section 6662 accuracy-related

penalty is due with respect to both of petitioners' tax returns

for 1993 and 1994.    Section 6662 imposes a penalty equal to 20

percent of the portion of the underpayment attributable to

negligence or disregard of rules or regulations.     Sec. 6662(a)

and (b)(1).   Negligence is defined as any failure to make a

reasonable attempt to comply with the provisions of the Internal

Revenue Code, and the term "disregard" includes any careless,

reckless, or intentional disregard.     Sec. 6662(c).
                                 - 9 -


     The accuracy-related penalties will apply unless petitioners

demonstrate that there was reasonable cause for the under-

payments and that they acted in good faith with respect to the

underpayments.   Sec. 6664(c).   Whether a taxpayer acted with

reasonable cause and good faith depends on the pertinent facts

and circumstances.   McCallson v. Commissioner, T.C. Memo. 1993-

528; sec. 1.6664-4(b)(1), Income Tax Regs.       Petitioners must show

that they were not negligent.     Cluck v. Commissioner, 105 T.C.

324, 339 (1995).

     Petitioners failed to produce any evidence to show that they

were not negligent for either of the years at issue.       They have

failed to carry their burden of proof.       We sustain respondent's

determination that they are liable for the accuracy-related

penalty for 1993 and 1994.

     To reflect the foregoing,

                                         Decision will be entered

                                 for respondent.
