                         T.C. Memo. 2004-213



                       UNITED STATES TAX COURT



   TIBOR GUENTHER HORWATH and CHRISTEL HORWATH, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 16927-02.                  Filed September 21, 2004.



     Tibor Guenther Horwath and Christel Horwath, pro sese.

     Dustin M. Starbuck, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


     CHIECHI, Judge:    Respondent determined the following defi-

ciencies in, and accuracy-related penalties under section 6662(a)

on, petitioners’ Federal income tax (tax):

        Year                Deficiency   Accuracy-Related Penalty
        1997                $58,427.00           $7,157.80
        1998                 45,435.00            6,824.40
                                - 2 -

       The issues remaining for decision are:

       (1) Are petitioners entitled for each of the taxable years

at issue to the depreciation deduction that they claim?    We hold

that they are not.

       (2) Are petitioners entitled for the taxable year 1998 to a

deduction of $14,686 for travel expenses?     We hold that they are

not.

       (3) Are petitioners liable for each of the taxable years at

issue for the accuracy-related penalty under section 6662(a)1?

We hold that they are.

                           FINDINGS OF FACT

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

       Petitioners resided in Falmouth, Virginia, at the time they

filed the petition in this case.

       In 1988, petitioners formed TG&C Associates, Inc. (TGC), an

S corporation, that at all relevant times provided consulting

services to various corporate and government entities.    At all

relevant times, TGC’s principal place of business was located in

petitioners’ residence.

       During the taxable years at issue, petitioners were the only

two stockholders of TGC.    For each of the taxable years at issue,

each petitioner had a zero basis in the TGC stock that each


       1
      All section references are to the Internal Revenue Code
(Code) in effect for the years at issue. All Rule references are
to the Tax Court Rules of Practice and Procedure.
                                - 3 -

owned.

     During the taxable years at issue, petitioner Tibor Guenther

Horwath (Mr. Horwath) occasionally provided consulting services

as a sole proprietorship known as “Tibor G. Horwath, Consulting”

(Tibor Horwath Consulting).

Claimed Depreciation Deductions

     On June 24, 1992, TGC entered into contract DASG60-92-C-0069

(1992 contract) with the United States Army Strategic Defense

Command (SDC).   During the course of the 1992 contract, SDC paid

TGC a total of $1,049,117.

     The 1992 contract provided in pertinent part with respect to

the specific tasks to be completed pursuant to that contract:

     The following specific tasks will be performed under
     the proposed program:

     Phase I:

          (1)    Design and construct an experimental
                 SSPG [small spinning projectile guid-
                 ance] seeker and associated laboratory
                 setup for open loop performance evalua-
                 tion of the concept against computer
                 generated and recorded, single and mul-
                 tiple target and background images.

          (2)    Evaluate the performance of the SSPG
                 seeker for various target and background
                 conditions, including the presence of
                 detector noise.

          (3)    Determine performance limits for the
                 SSPG seeker in terms of minimum detect-
                 able line of sight motion to the target,
                 and its ability to extract target fea-
                 ture information.
                           - 4 -

     (4)    Conduct analysis to determine valid
            parameter ranges for follow-on simula-
            tion effort, and attempt to define pro-
            jected hardware implementations.

     (5)    Prepare an interim report of the find-
            ings and recommendations.

Phase II:

     (1)    Adapt the open loop SSPG seeker labora-
            tory experiment for interfacing with a
            6-DOF flight dynamics computer code for
            a hardware in the loop simulation.

     (2)    Design and construct a line of sight
            (LOS) processor to extract guidance
            information from the SSPG seeker output
            signals.

     (3)    Modify and update the existing 6-DOF
            flight dynamics code to include rapid
            spin and nutation, and optimize the code
            for interface with the line of sight
            processor and other relevant laboratory
            hardware.

     (4)    Assemble the hardware in the loop simu-
            lation model using the above components,
            debug and calibrate, and perform simula-
            tion runs against simulated single and
            multiple target and background images.

     (5)    Transfer the hardware and software of
            the simulation effort to the KHILS fa-
            cility, interface with the KHILS equip-
            ment and conduct simulation against
            typical strategic and theater missile
            defense scenarios.

     (6)    Conduct a top level projectile design,
            defining a basic configuration, essen-
            tial parameters like mass, moments,
            ballistic characteristics, and guidance
            and control, for various potential ap-
            plications.

     (7)    Prepare an interim report and material
                                    - 5 -

                    for a briefing to the Government.

Phase III:

              (1)   Conduct an analysis effort aimed at
                    determining the optimum selection of
                    field test conditions, scaling of param-
                    eters and target representations, and
                    prepare a test plan.

              (2)   Design and construct an experimental
                    guided SSPG test vehicle and launcher to
                    be used in field tests.

              (3)   Repackage and miniaturize the laboratory
                    SSPG seeker and line of sight processor
                    and integrate into the test vehicle,
                    together with thrusters, solenoid valves
                    and cold propellant reservoir.

              (4)   Define specific parameters of the field
                    experiment by using the hardware in the
                    loop simulation model adapted for the
                    characteristics of the experimental test
                    vehicle.

              (5)   Conduct field tests with various targets
                    and test conditions and document and
                    analyze test data.

              (6)   Prepare a final report for the entire
                    effort and put together a briefing for
                    the Government.

     The 1992 contract provided in pertinent part with respect to

certain contract data requirements:

                     CONTRACT DATA REQUIREMENTS LIST

          *          *        *       *       *        *       *

     1)    A001     2)   Funds & Man-hour Expenditure Report

          *          *        *       *       *        *       *

     16) First report due 15 calendar days after first full
     accounting period. Submissions will include both the
                             - 6 -

formatted report and a columned report reflecting the
time-phased expenditure and forecast, on a cumulative
basis by month, through the period of performance. A
formatted report and columned report will be submitted
for the total contract. Graphic plots are not re-
quired.

1)    A002   2)   Contract Funds Status Report

     *        *        *       *       *         *     *

16) First report due 15 days after first full account-
ing period. Columns 2-10 of blocks 12, 13, & 14 will
be headed to show a 6-month “Rolling Window” followed
by remaining projections by FY. “Rolling Window” is
defined as a projection for each of the next 6 months
from the reported date. This will be followed by a
projection for remaining month by fiscal year.

1)    A003   2)   Innovations Report

     *        *        *       *       *         *     *

16) Submit draft Innovations Report MLT 2 months after
identification to address in BLK 6. Government com-
ments will be provided in 15 days: update and distrib-
ute within 15 days.

     *        *        *       *       *         *     *

1)    A005   2)   Quarterly Progress Report

     *        *        *       *       *         *     *

16) Initial report is to cover period ending first 3
months following contract award. Report is due 15 days
after completion of each quarters effort. When report
is presented orally, provide copies of viewgraphs and
narratives to attendees.


1)    A006   2)   Scientific & Technical Reports Summary

     *        *        *       *       *         *     *

16) Submit final draft 60 days prior to end of the
contract. The government comments will be provided
within 30 days. A final version shall be delivered at
                                - 7 -

     EOC. The contractor shall identify, control, and
     document any hazards and control procedures associated
     with the process and include this documentation in the
     final report. Any design, modeling, and hardware
     resulting from this effort shall become government
     property.

     Pursuant to the 1992 contract, TGC, inter alia, designed and

constructed a computer simulator (computer simulator) that

consisted of a large calibrated star display, various computers,

a precision spin and positioning platform for seeker hardware,

assorted electronic devices, and special software developed for

controlling that equipment.    After TGC completed the testing and

analysis required by the 1992 contract, TGC was to transfer the

computer simulator and associated software to a United States

government facility in Florida for further testing.

     On May 14, 1996, TGC entered into contract DASG60-96-C-0042

(1996 contract) with SDC.   Pursuant to the 1996 contract, TGC was

to use the computer simulator, when completed, to study various

technical matters related to strategic intercept with low-cost

precision intercept devices.   Pursuant to that contract, SDC was

to pay TGC a total of $8,169,616.

     On or about December 17, 1996, TGC completed the design,

construction, and testing of the computer simulator.   The com-

puter simulator was not transferred at that time or any other

time to the United States government facility in Florida.

     On November 6, 1997, petitioner Christel Horwath (Ms.

Horwath) executed on behalf of TGC a document entitled “Contrac-
                               - 8 -

tor’s Release and Assignment” (1997 release) with respect to the

1992 contract.   The 1997 release provided in pertinent part:

          Pursuant to the terms of Contract No. DASG60-92-C-
     0069 [1992 contract] and in consideration of the sum of
     One Million Fourty [sic] Nine Thousand One Hundred
     Seventeen Dollars and NO cents ($1,049,117.00) which
     has been or is to be paid under said contract with TG&C
     Associates, Inc. (hereinafter called “the Contractor”)
     or its assignees, if any, the Contractor, upon payment
     of said sum by the UNITED STATES OF AMERICA (hereinaf-
     ter called “the Government”), does hereby:

               1.   Remise, release and discharge the
          Government, its officers, agents, and employ-
          ees of or from all liabilities, obligations,
          claims, and demands, whatsoever, under or
          arising from the Contract * * *

     At the time the 1992 contract was terminated, the computer

simulator was the property of TGC.     During the taxable years at

issue and continuing until the time of trial in this case, the

computer simulator was located in the basement of petitioners’

residence.

     On February 18, 1998, TGC filed a formal complaint with the

Missile Defense Command concerning improper disclosure of TGC’s

proprietary data.

     On May 27, 1998, SDC notified TGC by letter that it was

terminating the 1996 contract pursuant to that contract’s limita-

tion of funds clause.   As of that date, SDC had paid TGC only

$1,015,805 of the original contract amount of $8,169,616.

     On March 31, 1999, TGC entered into a contract (1999 con-

tract) with the United States Army Armament Research, Develop-
                                - 9 -

ment, and Engineering Center Tank-Automotive and Armaments

Command, Armament Research, Development, and Engineering Center

located at Picatinny Arsenal.   Pursuant to the 1999 contract, TGC

was to modify the computer simulator in order to accommodate

tactical projectiles and perform tests in order to make it

possible to evaluate smart munitions technology.

     TGC entered into additional contracts after the 1999 con-

tract that required TGC to use the computer simulator.

Claimed Travel Expense Deduction

     During the taxable years at issue, TGC had a contract

(Primex contract) with Primex Technologies, Inc. (Primex) under

which TGC was to provide consulting services to Primex.    TGC

retained Tibor Horwath Consulting (i.e., Mr. Horwath) and Ms.

Jean P. Smith (Ms. Smith) to provide to Primex on TGC’s behalf

the consulting services required by the Primex contract.    The

services that Mr. Horwath and Ms. Smith were to provide to Primex

on TGC’s behalf required Mr. Horwath and Ms. Smith to travel

extensively.   Primex agreed to pay TGC for such travel expenses.

     Pursuant to the Primex contract, TGC sent Primex an invoice

every month.   Each such invoice reflected, inter alia, a separate

category labeled “Expenses by Dr. Tibor G. Horwath” and “Expenses

by Jean P. Smith”, which listed the respective travel expenses

paid by Mr. Horwath and Ms. Smith in providing to Primex on TGC’s

behalf the consulting services required by the Primex contract.
                               - 10 -

TGC treated as income all payments that it received from Primex

pursuant to the Primex contract, including payments for the

respective travel expenses of Mr. Horwath and Ms. Smith.

       During 1998, Mr. Horwath paid $16,812 in travel expenses in

connection with providing to Primex on TGC’s behalf the consult-

ing services required by the Primex contract.    Mr. Horwath was

entitled to a reimbursement by TGC for those travel expenses.

Mr. Horwath chose not to be reimbursed by TGC for the travel

expenses that he paid in 1998.

Petitioners’ Tax Returns

       Petitioners filed Form 1040, Individual Income Tax Return

(Form 1040), for each of the taxable years at issue, which Ms.

Horwath prepared.    (We shall refer to Forms 1040 that petitioners

filed for taxable years 1997 and 1998 as petitioners’ 1997 return

and petitioners’ 1998 return, respectively.)    In petitioners’

1997 return, petitioners claimed for the first time a deprecia-

tion deduction with respect to the computer simulator when in

Schedule C, Profit and Loss from Business (Schedule C), of that

return (Mr. Horwath’s 1997 Schedule C), they claimed such a

deduction of $75,250.    In Form 4562, Depreciation and Amortiza-

tion (Form 4562), relating to Mr. Horwath’s 1997 Schedule C,

petitioners claimed a basis of $215,000 in the computer simula-

tor.    The $215,000 basis in the computer simulator that petition-

ers claimed in Form 4562 represented their best estimate of the
                              - 11 -

replacement cost of that simulator.    In Schedule C of petition-

ers’ 1998 return (Mr. Horwath’s 1998 Schedule C), petitioners

claimed a depreciation deduction of $57,100 with respect to the

computer simulator and a deduction of $16,812 for the travel

expenses that Mr. Horwath paid in 1998.

Notice of Deficiency

     On August 1, 2002, respondent issued to petitioners a notice

of deficiency (notice) with respect to their taxable years 1997

and 1998.   In that notice, respondent determined, inter alia,

that petitioners are not entitled to the depreciation deductions

of $75,250 and $57,100 claimed with respect to the computer

simulator in petitioners’ 1997 return and petitioners’ 1998

return, respectively.   Respondent also determined in the notice,

inter alia, that petitioners are not entitled to $14,686 of the

$16,812   deduction that petitioners claimed for the travel

expenses that Mr. Horwath paid in 1998.2   Respondent further

determined in the notice that petitioners are liable for each of

the taxable years at issue for the accuracy-related penalty under



     2
      Petitioners claimed a deduction of $16,812 for travel
expenses in petitioners’ 1998 return. Respondent allowed $2,126
of that amount. The record does not disclose why respondent
allowed $2,126 of the claimed $16,812 travel expenses. The
parties stipulated that the entire amount of travel expenses
(i.e., $16,812) was paid by Mr. Horwath in connection with
providing to Primex on TGC’s behalf the consulting services
required by the Primex contract. (We shall refer to the $14,686
in travel expense that respondent disallowed in the notice as Mr.
Horwath’s 1998 travel expenses.)
                              - 12 -

section 6662(a).

                              OPINION

     Petitioners bear the burden of proving that the determina-

tions in the notice are erroneous.3     See Rule 142(a); Welch v.

Helvering, 290 U.S. 111, 115 (1933).

Claimed Depreciation Deductions

     Petitioners no longer contend that they are entitled to the

respective depreciation deductions that they claimed in petition-

ers’ 1997 return and petitioners’ 1998 return.     That is because,

according to petitioners:   (1) SDC transferred the computer

simulator to TGC by gift; (2) SDC’s alleged gift of the computer

simulator to TGC was a gift to petitioners as the stockholders of

TGC for purposes of determining any depreciation deductions

allowable with respect to that simulator; (3) pursuant to section

1015(a), petitioners’ basis in that simulator for such purposes

is SDC’s cost of, and thus its basis in, that simulator; and

(4) SDC’s cost of, and thus its basis in, the computer simulator



     3
      The parties do not address the application of sec. 7491(a)
or (c) in the instant case. Petitioners filed petitioners’ 1997
return on or about Aug. 15, 1998, and petitioners’ 1998 return on
or about July 16, 1999. We presume that respondent's examination
of those returns began after July 22, 1998, and that sec. 7491(a)
and (c) is applicable in the instant case. However, petitioners
do not argue that the burden of proof shifts to respondent under
sec. 7491(a). Even if petitioners had advanced such an argument,
they have not established that they have complied with the
applicable requirements of sec. 7491(a)(2). Under the circum-
stances presented here, we conclude that the burden of proof does
not shift to respondent under sec. 7491(a).
                                - 13 -

is the amount that SDC paid to TGC pursuant to the 1992 contract,

i.e., $1,049,117, and not the $215,000 that petitioners claimed

in Form 4562 relating to Mr. Horwath’s 1997 Schedule C.

     Respondent disagrees with the foregoing contentions of

petitioners.     However, respondent appears to agree with petition-

ers, albeit for reasons different from those advanced by them,

that petitioners, as the stockholders of TGC, would be entitled

to any depreciation deductions for the taxable years at issue

with respect to the computer simulator that the Court were to

allow.   In support of that position, respondent asserts on brief:

     during the years at issue, petitioners were the only
     shareholders of TG&C; thus, they controlled the com-
     puter simulator and the depreciation deduction would
     have flowed through to them. Thus, the net effect on
     petitioners is the same whether the depreciation deduc-
     tion is taken on Schedule C or flowed through to them.
     * * *

     On the record before us, we reject the foregoing position of

respondent as contrary to section 1366(d)(1).     Section 1366(d)(1)

provides:

     SEC. 1366.    PASS-THRU OF ITEMS TO SHAREHOLDERS

         *        *       *       *       *        *         *

             (d) Special Rules for Losses and Deductions.--

                  (1) Cannot exceed shareholder’s basis in
             stock and debt.--The aggregate amount of
             losses and deductions taken into account by a
             shareholder under subsection (a) for any
             taxable year shall not exceed the sum of--

                       (A) the adjusted basis of the share-
                  holder’s stock in the S corporation (deter-
                              - 14 -

               mined with regard to paragraphs (1) and
               (2)(A) of section 1367(a) for the taxable
               year), and

                    (B) the shareholder’s adjusted basis of
               any indebtedness of the S corporation to the
               shareholder (determined without regard to any
               adjustment under paragraph (2) of section
               1367(b) for the taxable year).

     For each of the taxable years at issue, each petitioner had

a zero basis in the TGC stock that each owned.4   Respondent is

thus wrong in asserting on brief that the “net effect on peti-

tioners is the same whether the depreciation deduction is taken

on Schedule C or flowed through to them [from TGC, an S corpora-

tion].”

     We turn now to petitioners’ position that for purposes of

determining any depreciation deductions allowable with respect to

the computer simulator “TG&C is an S-corporation, [and] the

simulation equipment, which was a gift for [sic] the company,

represents a gift to its stockholders.”   As support for petition-

ers’ position, petitioners point to section 25.2511-1(c)(1) and

(g)(1), Gift Tax Regs.5   Petitioners’ reliance on those regula-


     4
      Petitioners do not contend, and the record does not estab-
lish, that for each of the taxable years at issue they had any
basis in any indebtedness of TGC to them.
     5
      Petitioners may have intended to rely on sec. 25.2511-
1(h)(1), Gift Tax Regs., and not sec. 25.2511-1(g)(1), Gift Tax
Regs., for their position that any gift of the computer simulator
that SDC made to TGC was a gift to petitioners as the stockhold-
ers of TGC. Our response to any such reliance by petitioners on
sec. 25.2511-1(h)(1), Gift Tax Regs., is the same as our response
                                                   (continued...)
                              - 15 -

tions is misplaced.   Section 25.2511-1(c)(1) and (g)(1), Gift Tax

Regs., deal only with the Federal gift tax and do not support

petitioners’ position that for Federal income tax purposes they

are entitled to the depreciation deductions that they are claim-

ing with respect to the computer simulator.

     Assuming arguendo that any gift of the computer simulator by

SDC to TGC were to be treated as a gift of that simulator to

petitioners for Federal gift tax purposes, it does not follow

that petitioners, as the stockholders of TGC, are entitled to

depreciation deductions for Federal income tax purposes with

respect to that simulator.   A stockholder:

     is not usually entitled to a depreciation deduction for
     property owned by his corporation because he has no
     direct economic interest or investment in the property.
     * * * Where the corporation is the owner of the prop-
     erty and uses it in its business, the corporation, not
     the stockholders, is entitled to the depreciation
     deduction.

Hunter v. Commissioner, 46 T.C. 477, 490 (1966).

     On the record before us, we find that, assuming arguendo

that we were to accept petitioners’ arguments that SDC trans-

ferred the computer simulator to TGC by gift and that any such

gift to TGC represented a gift for Federal gift tax purposes to

petitioners as the stockholders of TGC, petitioners have failed

to establish that they are entitled for the taxable years at


     5
      (...continued)
set forth below to their reliance on sec. 25.2511-1(c)(1) and
(g)(1), Gift Tax Regs.
                                - 16 -

issue to the respective depreciation deductions that they are

claiming with respect to that simulator.6

     For the sake of completeness, we shall address whether,

assuming arguendo (1) that SDC transferred the computer simulator

to TGC by gift and (2) that any such gift is treated as a gift to

petitioners for purposes of determining petitioners’ entitlement

for the taxable years at issue to depreciation deductions with

respect to that simulator, petitioners have established the

amounts of such depreciation deductions to which they are enti-

tled.    Petitioners argue that their basis in the computer simula-

tor under section 1015(a) is SDC’s basis in that simulator, i.e.,

SDC’s cost of that simulator.    According to petitioners, SDC’s

cost of, and thus its basis in, the computer simulator was

$1,049,117, the amount that SDC paid to TGC pursuant to the 1992

contract, and not the $215,000 that petitioners claimed in Form

4562 relating to Mr. Horwath’s 1997 Schedule C.7

     On the record before us, we reject petitioners’ argument.

Section 167(c) provides in pertinent part:    “The basis on which



     6
      The record establishes that at the time the 1992 contract
was terminated around Nov. 6, 1997, the computer simulator was
the property of TGC. Assuming arguendo that SDC transferred the
computer simulator to TGC by gift, the record does not establish
that TGC owned the computer simulator prior to the termination of
the 1992 contract.
     7
      The $215,000 that petitioners claimed as their basis in the
computer simulator in Form 4562 represented petitioners’ best
estimate of the replacement cost of that simulator.
                               - 17 -

exhaustion, wear and tear, and obsolescence are to be allowed in

respect of any property shall be the adjusted basis provided in

section 1011".   As pertinent here, section 1011(a) defines the

term "adjusted basis" as the basis determined under section 1012,

adjusted as provided under section 1016, and section 1012 pro-

vides that the basis of property is its cost.   Section 1016(a)(2)

provides in pertinent part that adjustments in respect of prop-

erty shall be made, inter alia, to the extent of the amount of

depreciation deductions allowed for that property.   Section

1015(a) provides in pertinent part that if “property was acquired

by gift after December 31, 1920, the basis shall be the same as

it would be in the hands of the donor”.

     Assuming arguendo (1) that SDC transferred the computer

simulator to TGC by gift, (2) that any such gift is treated as a

gift to petitioners for purposes of determining petitioners’

entitlement for the taxable years at issue to depreciation

deductions with respect to that simulator, and (3) that petition-

ers’ basis in the computer simulator under section 1015(a) is

SDC’s cost of, and thus its basis in, that simulator, we must

determine SDC’s cost of that simulator.

     Petitioners contend that SDC’s cost of the computer simula-

tor is the amount that SDC paid to TGC pursuant to the 1992

contract (i.e., $1,049,117).   On the record before us, we reject

that contention.   SDC paid $1,049,117 to TGC pursuant to the 1992

contract for all of the work that TGC performed under that
                              - 18 -

contract.   The work that TGC was to perform under the 1992

contract included 18 discrete tasks, only one of which was to

design and construct the computer simulator.   Other tasks re-

quired TGC, inter alia, to perform tests, to analyze the results

from those tests, to design and construct a test vehicle and

launcher, and to prepare various reports for SDC.

     On the record before us, we find that, assuming arguendo

(1) that SDC transferred the computer simulator to TGC by gift,

(2) that any such gift is treated as a gift to petitioners for

purposes of determining petitioners’ entitlement for the taxable

years at issue to depreciation deductions with respect to that

simulator, and (3) that petitioners’ basis in the computer

simulator under section 1015(a) is SDC’s cost of, and thus its

basis in, that simulator, petitioners have failed to establish

that the amount that SDC paid to TGC pursuant to the 1992 con-

tract (i.e., $1,049,117) is SDC’s cost of, and thus its basis in,

the computer simulator.   See secs. 1011(a) and 1012.   On that

record, and making those assumptions arguendo, we further find

that petitioners have failed to carry their burden of establish-

ing (1) how much of the amount (i.e., $1,049,117) that SDC paid

to TGC pursuant to the 1992 contract was paid for the design and

construction of the computer simulator8 and therefore was SDC’s


     8
      The record contains a so-called funds and man-hour expendi-
ture summary (expenditure summary) which detailed the amounts
                                                   (continued...)
                             - 19 -

cost of, and basis in, that simulator, see secs. 1011(a) and

1012, or (2) any other basis in that simulator, see sec. 1.1015-

1(a)(3), Income Tax Regs.

     On the record before us, we find that, assuming arguendo

(1) that SDC transferred the computer simulator to TGC by gift,

(2) that any such gift is treated as a gift to petitioners for

purposes of determining petitioners’ entitlement for the taxable

years at issue to depreciation deductions with respect to that

simulator, and (3) that petitioners’ basis in the computer

simulator under section 1015(a) is SDC’s cost of, and thus its

basis in, that simulator, petitioners have failed to carry their

burden of establishing that they are entitled for the taxable

years at issue to the depreciation deductions that they are

claiming with respect to that simulator.




     8
      (...continued)
that TGC expended as of September 1996 pursuant to the 1992
contract. The amounts detailed in the expenditure summary were
for categories such as “DIRECT LABOR” (e.g., costs for 4880
Senior Technologist man-hours, costs for 2475 Mathematician man-
hours) and “CONSULTANTS”. The expenditure summary did not show
how much of those amounts TGC expended for the design and con-
struction of the computer simulator and how much of those amounts
TGC expended to complete the other tasks that it was obligated to
perform under the 1992 contract. In addition, the expenditure
summary indicated that as of September 1996 TGC spent a total of
$9,925 on “MATERIALS”. The expenditure summary did not indicate
how much of that amount TGC expended on materials for the com-
puter simulator and how much TGC expended on materials that it
needed to complete the other tasks that it was obligated to
perform under the 1992 contract.
                              - 20 -

Claimed Travel Expense Deduction

     Petitioners argue that Mr. Horwath’s 1998 travel expenses

are deductible under section 162(a) as ordinary and necessary

business expenses because Mr. Horwath paid those travel expenses

while performing consulting services for TGC.   Respondent coun-

ters that petitioners are not entitled to a deduction for Mr.

Horwath’s 1998 travel expenses because Mr. Horwath was entitled

to a reimbursement by TGC for such expenses, which Mr. Horwath

elected not to request.

     On the record before us, we agree with respondent.   A

taxpayer is not entitled to a deduction for expenses to the

extent that such taxpayer is entitled to be reimbursed for such

expenses but does not claim such reimbursement.   See Levy v.

Commissioner, 212 F.2d 552, 554 (5th Cir. 1954), affg. a Memoran-

dum Opinion of this Court dated Mar. 9, 1953; Universal Oil

Prods. Co. v. Campbell, 181 F.2d 451, 475 (7th Cir. 1950); see

also Lucas v. Commissioner, 79 T.C. 1, 7 (1982); Kennelly v.

Commissioner, 56 T.C. 936, 943 (1971), affd. without opinion 456

F.2d 1335 (2d Cir. 1972); Stolk v. Commissioner, 40 T.C. 345, 356

(1963), affd. per curiam 326 F.2d 760 (2d Cir. 1964); Podems v.

Commissioner, 24 T.C. 21, 22-23 (1955); Roach v. Commissioner, 20

B.T.A. 919, 925-926 (1930).   Mr. Horwath was entitled to a

reimbursement by TGC for Mr. Horwath’s 1998 travel expenses.

However, he chose not to be reimbursed for those expenses.
                              - 21 -

     On the record before us, we find that petitioners have

failed to establish that they are entitled to a deduction for the

taxable year 1998 for Mr. Horwath’s 1998 travel expenses.

Accuracy-Related Penalty

     Respondent argues that petitioners are liable for each of

the taxable years at issue for the accuracy-related penalty under

section 6662(a) because of negligence or disregard of rules or

regulations under section 6662(b)(1) or a substantial understate-

ment of income tax under section 6662(b)(2).

     Respondent has the burden of production under section

7491(c) with respect to the accuracy-related penalty under

section 6662(a).9   To meet that burden, respondent must come

forward with sufficient evidence indicating that it is appropri-

ate to impose the relevant penalty.    Higbee v. Commissioner, 116

T.C. 438, 446 (2001).

     For purposes of section 6662(a), the term "negligence"

includes any failure to make a reasonable attempt to comply with

the Code, and the term "disregard" includes any careless, reck-

less, or intentional disregard.   Sec. 6662(c).   Negligence has

also been defined as a lack of care or failure to do what a

reasonable person would do under the circumstances.    Leuhsler v.

Commissioner, 963 F.2d 907, 910 (6th Cir. 1992), affg. T.C. Memo.

1991-179; Antonides v. Commissioner, 91 T.C. 686, 699 (1988),


     9
      See supra note 3.
                              - 22 -

affd. 893 F.2d 656 (4th Cir. 1990).

     The record establishes that petitioners used the estimated

replacement cost for the computer simulator in determining the

respective depreciation deductions claimed with respect to that

simulator in petitioners’ 1997 return and petitioners’ 1998

return.   The record also establishes that petitioners took a

deduction for Mr. Horwath’s 1998 travel expenses in petitioners’

1998 return even though Mr. Horwath was entitled to a reimburse-

ment by TGC for such expenses, which he chose not to claim.

     With respect to the respective depreciation deductions

relating to the computer simulator that petitioners claimed in

petitioners’ 1997 return and petitioners’ 1998 return, assuming

arguendo that petitioners were not negligent in claiming that

they, as the stockholders of TGC, were entitled to such deprecia-

tion deductions, the basis that they claimed in Form 4562 relat-

ing to Mr. Horwath’s 1997 Schedule C in determining those depre-

ciation deductions, namely, the estimated replacement cost of

that computer simulator, has no support in the Code, the regula-

tions, or the caselaw.   See secs. 167(c), 1011, 1012; secs.

1.167(a)-1(a), 1.1011-1, 1.1012-1(a), Income Tax Regs.; Meredith

Corp. & Subs. v. Commissioner, 102 T.C. 406, 423 (1994); Dumont-

Airplane & Marine Instruments, Inc. v. Commissioner, 28 T.C. 1308

(1957).

     With respect to the deduction for Mr. Horwath’s 1998 travel
                               - 23 -

expenses that petitioners claimed in petitioners’ 1998 return,

that deduction is not supported by the Code, the regulations, or

the caselaw.   See sec. 162(a); sec. 1.162-1(a), Income Tax Regs.;

Levy v. Commissioner, supra at 554; Universal Oil Prods. Co. v.

Campbell, supra at 475.

     On the record before us, we find that respondent has satis-

fied respondent’s burden of production under section 7491(c) with

respect to the accuracy-related penalties under section 6662(a)

determined in the notice.

     The accuracy-related penalty under section 6662(a) does not

apply to any portion of an underpayment if it is shown that there

was reasonable cause for, and that the taxpayer acted in good

faith with respect to, such portion.    Sec. 6664(c)(1).   The

determination of whether the taxpayer acted with reasonable

cause, or in good faith, depends on the pertinent facts and

circumstances, including the taxpayer's efforts to assess such

taxpayer’s proper tax liability, the knowledge and experience of

the taxpayer, and the reliance on the advice of a professional,

such as an accountant.    Sec. 1.6664-4(b)(1), Income Tax Regs.

     Petitioners argue that they had reasonable cause for, or

acted in good faith in, claiming the respective depreciation

deductions in petitioners’ 1997 return and petitioners’ 1998

return with respect to the computer simulator because that

simulator was a unique piece of equipment, and petitioners’
                              - 24 -

estimate of the replacement cost of the computer simulator was

reasonable.   On the record before us, we reject petitioners’

argument.   Petitioners were in a unique position to know SDC’s

cost of, and thus its basis in, the computer simulator.   That is

because they, acting on behalf of TGC, designed and constructed

that simulator and carried out the other work that TGC performed

for SDC under the 1992 contract.   Assuming arguendo that peti-

tioners were not negligent in claiming that they, as the stock-

holders of TGC, were entitled to the respective depreciation

deductions in petitioners’ 1997 return and petitioners’ 1998

return, on the record before us, we find, for the reasons set

forth above in our discussion of the basis under section 167(c)

on which a taxpayer may claim a depreciation deduction, that

petitioners did not have reasonable cause for, or act in good

faith in, using the estimated replacement cost of the computer

simulator in calculating such depreciation deductions.

     Petitioners advance no argument that they had reasonable

cause for, or acted in good faith in, claiming a deduction for

Mr. Horwath’s 1998 travel expenses in petitioners’ 1998 return.

In any event, petitioners knew that Mr. Horwath was entitled to a

reimbursement by TGC for Mr. Horwath’s 1998 travel expenses and

that Mr. Horwath chose not to be reimbursed by TGC for such

expenses.   On the record before us, we find that petitioners have

failed to establish that they had reasonable cause for, or acted
                              - 25 -

in good faith in, claiming a deduction for Mr. Horwath’s 1998

travel expenses in petitioners’ 1998 return.

     On the record before us, we find that petitioners have

failed to show that they were not negligent and did not disregard

rules or regulations within the meaning of section 6662(b)(1), or

otherwise did what a reasonable person would do, with respect to

the underpayment for each of the taxable years at issue.     On that

record, we further find that petitioners have failed to show that

they acted with reasonable cause, or in good faith, with respect

to each such underpayment.   See sec. 6664(c)(1).   On the record

before us, we find that petitioners have failed to establish that

they are not liable for the accuracy-related penalty under

section 6662(a) for each of the taxable years at issue.10

     We have considered all of the contentions and arguments of

the parties that are not discussed herein, and we find them to be

without merit, irrelevant, and/or moot.11


     10
      We have found that petitioners are liable for each of the
taxable years at issue for the accuracy-related penalty under
sec. 6662(a) because of negligence or disregard of rules or
regulations under sec. 6662(b)(1). In light of that finding, we
shall not address respondent’s alternative argument that peti-
tioners are liable for each of the taxable years at issue for the
accuracy-related penalty under sec. 6662(a) because of a substan-
tial understatement of income tax under sec. 6662(b)(2).
     11
      Petitioners advance certain contentions and arguments
relating to the ownership of the computer simulator and SDC’s
alleged transfer by gift of the computer simulator to TGC. We do
not address those contentions and arguments because, even if we
were to accept them, on the instant record we nonetheless reject
                                                   (continued...)
                             - 26 -

     To reflect the foregoing and the concessions of petitioners,


                                   Decision will be entered for

                              respondent.




     11
      (...continued)
petitioners’ position that they are entitled to the depreciation
deductions claimed with respect to the computer simulator for the
taxable years 1997 and 1998.
