                        T.C. Memo. 1997-99



                      UNITED STATES TAX COURT



              EDWARD AND RUTH KELLY, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent*



     Docket Nos. 28233-91, 7795-94.      Filed February 25, 1997.



     Geoffrey J. O'Connor, for petitioner Edward Kelly.

     Norman Trabulus, for petitioner Ruth Kelly.

     Andrew J. Mandell and Lewis J. Abrahams, for respondent.



                 SUPPLEMENTAL MEMORANDUM OPINION


     BEGHE, Judge:   In our recently filed Memorandum Findings of

Fact and Opinion in these cases (T.C. Memo. 1996-529) (the

Opinion), we sustained respondent's determinations of
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         *
       This opinion supplements our previously filed Memorandum
Findings of Fact and Opinion in Kelly v. Commissioner, T.C. Memo.
1996-529, filed Dec. 2, 1996.
deficiencies, additions to tax, and penalties, and denied the

claim of petitioner Ruth Kelly (petitioner) to relief from

liability as an innocent spouse under section 6013(e).1   The

Opinion is incorporated herein by this reference.

     Petitioner filed a timely motion for reconsideration,

pursuant to Rule 161.   Respondent filed a notice of objection and

memorandum of argument and authorities.    Petitioner Edward Kelly

has not filed a response to petitioner's motion.

     Petitioner argues that the Court incorrectly held that the

deductions for ordinary losses and for business expenses claimed

on the joint returns were not "grossly erroneous" within the

meaning of section 6013(e)(2)(B), as having "no basis in fact or

law", that upon reconsideration, the Court should conclude that

the husband's loss deductions claimed on the joint return

satisfied the "grossly erroneous" test, and that the Court should

proceed to determine that petitioner satisfied each of the other

requirements for innocent spouse status.

     Specifically, petitioner argues that the Court, in rejecting

her argument that the deductions claimed were "phony", failed to

address whether they were "groundless" or "frivolous", and that,



     1
      Except where otherwise noted, all section references are to
sections of the Internal Revenue Code in effect for the years in
issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure.
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even if the losses claimed were not "phony", they were groundless

and frivolous because courts have sustained criminal convictions

for claims of ordinary loss treatment by persons who were traders

rather than dealers.   Petitioner also argues that the Court

applied inconsistent standards in determining that petitioners

were liable for negligence and substantial understatement

additions for 1986 and 1987 and accuracy-related penalties for

1988-92 with respect to the claimed ordinary losses and

unsubstantiated business expense deductions, while holding that

the claimed ordinary losses and expense deductions were not

grossly erroneous for the purpose of sustaining petitioner's

entitlement to innocent spouse treatment.

     The granting of a motion for reconsideration is within the

discretion of the Court.   Such a motion is generally denied in

the absence of a showing of unusual circumstances or substantial

error.   CWT Farms, Inc. v. Commissioner, 79 T.C. 1054, 1057

(1982), affd. 755 F.2d 790 (11th Cir. 1985); Lucky Stores, Inc.

v. Commissioner, T.C. Memo. 1997-70.   Petitioner's motion shows

no unusual circumstances or substantial error and will therefore

be denied.   However, for purposes of completeness, we will

address the arguments in petitioner's motion.

     1. Petitioner's Contention That Ordinary Loss Treatment of
the Option Transactions Was Grossly Erroneous

     Petitioner contends, as she did on brief, that the return

treatment of the option losses as ordinary losses was
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"groundless" and "frivolous" because other defendants have been

criminally convicted for doing what petitioner Edward Kelly did.

In United States v. Wood, 943 F.2d 1048 (9th Cir. 1991), the

first case relied on by petitioner, the taxpayer was charged with

tax evasion arising from unreported income derived from his

embezzlement of funds placed with him for investment.   One of the

taxpayer's defenses was that he had no tax liability because he

had lost the funds in the commodities market and that the losses

were fully deductible from the embezzlement income.   The

Government argued that the losses were capital and not fully

deductible because, as in the case at hand, the defendant had no

customers and traded exclusively for his own account.   The

defendant was convicted of evasion because he embezzled and did

not report the income, not because he claimed ordinary loss

treatment as one of his defenses.

     In the second case relied on by petitioner, United States v.

Diamond, 788 F.2d 1025 (4th Cir. 1986), the defendant, who had

claimed ordinary loss treatment of his commodities losses, was

convicted of signing false returns because the evidence

established, among other things, his education and professional

experience (C.P.A., J.D., M.B.A., LL.M.), suggesting an

extraordinary sophistication with respect to tax matters; that he

reported trading losses in prior and subsequent years as capital

losses and caused his father to report his losses from similar

activity in 1980; that he directed his employer to withhold
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additional taxes from his wages in order to avoid the estimated

payment penalty he had incurred in prior years, suggesting that

his decision to deduct his trading losses as ordinary losses was

merely an afterthought; and perhaps most important, the false

characterization of his trading activity and business name on the

1980 Schedule C, suggesting that he knew that accurate

description would trigger inspection and ultimate disallowance of

the ordinary loss deduction by the Internal Revenue Service.     Id.

at 1030.   In Diamond, the defendant was convicted of filing false

returns, not, as petitioner suggests, simply because he

mischaracterized his commodities losses.   The mischaracterization

of the losses was only a small part of the defendant's

sophisticated scheme to avoid taxes.

     Recent developments, subsequent to issuance of the Opinion

and our reliance on Reid v. Commissioner, T.C. Memo. 1989-294,

confirm that Mr. Kelly's position, although incorrect, was not

groundless or frivolous.   Other individual taxpayers, during

years in issue in the case at hand, made good faith claims that

they were entitled to ordinary loss treatment as dealers in

securities.   The Court has rejected these claims, Marrin v.

Commissioner, T.C. Memo. 1997-24; Hart v. Commissioner, T.C.

Memo. 1997-11, and upheld the imposition of additions for late

filing, as well as negligence and substantial understatement

additions, in the face of the taxpayers' arguments that they

believed that their ordinary losses from securities transactions
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zeroed out their income tax liabilities, Marrin v. Commissioner,

supra; Cohen v. Commissioner, T.C. Memo. 1996-546.     See generally

Raby & Raby, "Ordinary Deductions, but Capital Losses for

Securities Traders", Tax Notes 611 (Feb. 3, 1997), discussing

these and other recent cases in this area.

     Petitioner also argues that the Opinion is internally

inconsistent.   Petitioner asserts that, in finding that Mr. Kelly

did not act with fraudulent intent, the Court has relied upon Mr.

Kelly's representation to his accountant that he was licensed to

do business as an options dealer, a representation which the

Court rejects as false, but to which it holds petitioner since,

on brief, she did not contest its accuracy.    Petitioner goes on

to claim that in sustaining the additions to tax under section

6653(a), the Court applied a contrary analysis, rejecting Mr.

Kelly's claim of reliance upon his accountant because the Court

found that he had not shown that he provided his accountant with

complete and accurate information.

     The Court has not rejected as false Mr. Kelly's

representation to his accountant that he was licensed to do

business as an options dealer.    The Court stated:   "Considering

the importance of this allegation to Mr. Kelly's theory of the

case, one would have expected him to present evidence verifying

its accuracy.   He did not."

     The Court found, as one of the weaknesses to petitioner's

argument that the option losses were grossly erroneous, that Mr.
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Auerbach, an experienced tax professional, as well as petitioner,

accepted the accuracy of Mr. Kelly's representation that

registration as an options principal qualified him to do business

as an options dealer.   This led the Court to conclude that Mr.

Kelly's representation did not constitute such a substantial

deviation from ordinary behavior that it could not be ascribed to

an honest misunderstanding or simple carelessness.

     There is no inconsistency in the Court's also finding that

petitioners were liable for the additions to tax pursuant to

section 6653.   Any part of an underpayment attributable to a

position taken by the taxpayer in reasonable, bona fide reliance

upon professional tax advice is not attributable to negligence.

Ewing v. Commissioner, 91 T.C. 396, 423-424 (1988), affd. without

published opinion 940 F.2d 1534 (9th Cir. 1991).   In order to

prove reasonable reliance on an accountant, the taxpayer must

demonstrate that he supplied his adviser with complete and

accurate information.    Pessin v. Commissioner, 59 T.C. 473, 489

1972); Enoch v. Commissioner, 57 T.C. 781, 803 (1972); Gill v.

Commissioner, T.C. Memo. 1994-92, affd. without published opinion

76 F.3d 378 (6th Cir. 1996).   The Court found that Mr. Kelly did

not show that his status as a registered options principal in

fact entitled him to open his own office and deal in options.

Thus he simply did not satisfy his burden of showing that he

provided his accountant with complete and accurate information on

this material point.    This finding is not inconsistent with the
                               - 8 -


Court's finding that Mr. Auerbach and petitioner accepted the

accuracy of Mr. Kelly's representation that registration as an

options principal qualified Mr. Kelly to do business as an

options dealer and that the representation did not constitute

such a substantial deviation from ordinary behavior that it could

not be ascribed to an honest misunderstanding or simple

carelessness.   Thus the evidence neither showed the

representation to be phony or fraudulent nor foreclosed the

possibility that the inaccuracy of the representation was due to

negligence on Mr. Kelly's part.

     Petitioner also claims, as she did on brief, that the record

showed that Mr. Auerbach did not advise Mr. Kelly that he had a

legitimate basis for ordinary loss treatment, but told him that

his license could serve as a pretext for such a claim.

Petitioner claimed that Mr. Kelly and Mr. Auerbach well knew that

Mr. Kelly was not in the business of dealing in options.

     There is nothing in the record to support these claims.    To

the contrary, Mr. Auerbach testified that he told Mr. Kelly that,

based on the information that he had, he believed that Mr. Kelly

was entitled to consider himself in the business of being a

dealer and that, after reviewing the position, Mr. Auerbach was

comfortable with Mr. Kelly's claiming ordinary losses on his

returns.
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     2. Petitioner's Contention That the Business Expense
Deductions Were Grossly Erroneous

     Petitioner contends, as she did on brief, that section

274(d) elevates substantiation from a procedural proof

requirement to an actual element of entitlement to the deduction,

and therefore, if there was no substantiation, the deductions

were grossly erroneous.

     In order to prove that the travel and entertainment expenses

that were claimed were grossly erroneous, petitioner must

demonstrate that the claimed losses had no basis in fact or law.

Sec. 6013(e)(2)(B).

     A deduction has no basis in fact when the expense for which

the deduction is claimed was never in fact made.   A deduction has

no basis in law when the expense, even if made, does not qualify

as a deductible expense under well-settled legal principles or

when no substantial legal argument can be made to support its

deductibility.   Thus, petitioner must   establish that the claimed

deductions were fraudulent, frivolous, or, to use the word of the

committee report,2 phony.   Bokum v. Commissioner, 94 T.C. 126

(1990), affd. 992 F.2d 1132 (11th Cir. 1993); Douglas v.

Commissioner, 86 T.C. 758, 762-763 (1986), affd. without

published opinion (10th Cir. June 28, 1989).




     2
      H. Rept. 98-432 (Part 2), at 1502 (1984).
                               - 10 -


     Petitioner may not rely on the disallowance or the failure

to substantiate the deductions alone to prove a lack of basis in

fact or law.   As the Court stated in Douglas:   "it simply does

not follow that because deductions lacking in a factual or legal

basis will be disallowed, all deductions which are disallowed

lack a factual or legal basis."     Douglas v. Commissioner, supra

at 763; Purcell v. Commissioner, 826 F.2d 470 (6th Cir. 1987),

affg. 86 T.C. 228 (1986).

     The substantiation requirement of section 274(d) would not

change the above analysis as to what constitutes grossly

erroneous deductions.    If petitioners had been able to adequately

substantiate Mr. Kelly's travel and entertainment expenses, those

expenses would have been fully deductible under well-settled

legal principles.

     Petitioner contends that if the entertainment expenses had a

factual basis, there is no logical explanation why they were not

reimbursed.    There is no indication that the unreimbursed

expenses were ever submitted to Mr. Kelly's employer, and no

explanations why they were not submitted.

     As discussed in respondent's briefs and by the Court, there

could be a number of logical explanations as to why Mr. Kelly was

not reimbursed for more expenses.    As respondent suggests, there

may have been an internal dollar limit in his department on the

amount of entertainment expenses that would be reimbursed, or Mr.
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Kelly might not have been bringing in enough business to warrant

being reimbursed for additional expenses.

     Any explanation why some of the expenses were not reimbursed

would be pure speculation, as petitioner's counsel chose not to

elicit any testimony from Mr. Kelly regarding his failure to

request and obtain reimbursement of his entertainment expenses

from his employer.

     Petitioner has offered no evidence to show that the

deductions in issue were grossly erroneous.   There has been no

showing that the deductions were "phony" or otherwise grossly

erroneous for purposes of the innocent spouse requirement.

Purcell v. Commissioner, supra.

               For the foregoing reasons,

                                        An order will be issued

                                   denying petitioner's Motion

                                   for Reconsideration.
