                          T.C. Memo. 2000-68



                      UNITED STATES TAX COURT



           FERYDOUN AHADPOUR, a.k.a. F. AHADPOUR, AND
                 DORIS AHADPOUR, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent


     Docket No. 4843-96.                        Filed March 2, 2000.


     William K. Norman, Edi Shawn Stiles, and E. O. C. Ord, for

petitioners.

     Louis B. Jack, T. Ian Russell, Elizabeth Stetson, and Sherri

Wilder, for respondent.


                          MEMORANDUM OPINION


     DAWSON, Judge:   This case was assigned to Special Trial

Judge Larry L. Nameroff pursuant to Rules 180, 181, and 183.1



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

The Court agrees with and adopts the opinion of the Special Trial

Judge, which is set forth below.

                 OPINION OF THE SPECIAL TRIAL JUDGE

     NAMEROFF, Special Trial Judge:      Respondent determined

deficiencies in petitioners’ Federal income taxes, additions to

tax, and penalties as follows:

                            Addition to Tax          Penalty
   Year       Deficiency    Sec. 6651(a)(1)       Sec. 6662(a)

   1989       $1,363,638       $340,560             $272,728
   1990          303,274          --                  60,655
   1991          237,234         60,864               47,447

     Some of the issues in this case were severed for separate

resolution and resolved in Ahadpour v. Commissioner, T.C. Memo.

1999-9.

     The issues for decision herein are:      (1) Whether petitioners

are entitled to a claimed business bad debt deduction; (2)

whether petitioners are entitled to deduct legal expenses of

$30,000 in 1990 and $30,025 in 1991; (3) whether petitioners are

liable for the accuracy-related penalty for all years at issue;

and (4) whether petitioners are liable for additions to tax under

section 6651(a)(1) for 1989 and 1991.

     Some of the facts have been stipulated, and they are so

found.    The stipulations of facts and the attached exhibits are

incorporated herein by this reference.     At the time they filed

their petition, petitioners resided in Huntington Beach,

California.
                                 - 3 -

                              Background

Family History2

     Petitioner Ferydoun Ahadpour (petitioner) was born in

Tehran, Iran.     By two prior marriages, he has three children,

Bahman (born December 12, 1954), Geila (born October 17, 1956),

and Bijan (born September 12, 1965).       Petitioner met Doris

Ahadpour (Mrs. Ahadpour), f.k.a Doris Peters and Doris Ashrafi,

an American, in 1968.     Mrs. Ahadpour had been living in Iran

since 1967.     During an 11-month visit to the United States in

1969, petitioners were married in Las Vegas, Nevada.       As a result

of the marriage, Mrs. Ahadpour became an Iranian citizen while

retaining her United States citizenship.

     Three children were born of petitioners’ marriage:       Diana

(a.k.a. Deanna) on December 17, 1969, David on November 26, 1972,

and Leila on June 3, 1980.     Petitioner’s native language is

Persian, and his English is limited.       Mrs. Ahadpour speaks

Persian, but she cannot read it.     Typically, Mrs. Ahadpour

interprets English for her husband.

The Marine Salvage Company in Iran

         Prior to the mid-1950's, petitioner worked for the Iranian

Government in the police department in Khorramshahr.       Around the

mid-1950's, he heard that a barge transporting steel had sunk.


     2
        In view of our disposition of the issues presented
herein, the issue of when petitioners established residency in
the United States is moot.
                               - 4 -

Petitioner found out that there were many sunken barges in the

rivers and in the Persian Gulf and believed that raising the

barges and their cargoes could be profitable.    Around 1956 or

1957, he purchased a barge and an old crane and mounted the crane

on the barge.   Petitioner purchased the rights to a sunken barge

from the insurance company.   With some hired help and the barge

and crane, petitioner raised the sunken barge.    This turned out

to be a successful venture.   Around 1958, he founded Gulf Divers,

a marine salvage company which he operated out of Khorramshahr.

In the next few years, Gulf Divers salvaged numerous sunken

barges and their cargoes.

     In subsequent years, the name of the business changed a few

times.   In 1968, the name of the business was changed to Persian

Gulf Diving Joint Stock Co.; in 1973, it was changed to Persian

Gulf Limited Liability Co.; and in 1975, it was changed for the

last time to Gulf Marine Service Co. (GMS).3    The name was

changed to GMS so the business would not be associated only with

diving, but also with a broader variety of marine operations such

as dredging, underwater repairs, and construction.


     3
        Hereinafter, the company is referred to as GMS for all
time periods for simplicity.
     Additionally, there is substantial evidence indicating that
GMS was incorporated between 1968 and 1975, but the necessity for
such determination is rendered moot by our disposition of the bad
debt issue. Consequently, we need not consider petitioners’
objections to the admission into evidence of excerpts from the
publication known as the Official Gazette of the Islamic Republic
of Iran.
                                 - 5 -

Hossein Ammareh

     Hossein Ammareh (Ammareh) was an employee at the National

Iranian Oil Company (NIOC) located near Khorramshahr.     Petitioner

first met Ammareh in 1968.     Ammareh had mechanical skills, and

petitioner hired him to work for GMS.     Ammareh speaks and writes

Persian.

     While petitioner was in the United States for 11 months in

1969 (and on his subsequent visits), Ammareh ran GMS without

incident.   In 1969, petitioner issued a power of attorney to

Ammareh allowing him to sell some property and equipment while

petitioner was out of Iran.4

     Ammareh’s responsibilities increased over the years.

Ammareh signed contracts with NIOC on behalf of GMS.     Petitioner

often referred to Ammareh as his partner.

Operations of GMS

     Initially, GMS was involved in diving and marine salvage

operations.   Throughout the years, the scope of GMS’s business

had increased to include dredging, jetty construction, placing

pillars and pipes underwater, and the unloading of pipes.     More

equipment was purchased such as barges, pontoons, cranes,




     4
        According to petitioner, Ammareh sold some of GMS’s
cranes. The power of attorney authorizes Ammareh to sell a piece
of real estate for petitioner, and there is no mention of the
business.
                                - 6 -
tugboats, and a warehouse.    GMS also leased the cranes and

equipment to other companies.

Sale of GMS

     Since petitioners were considering moving to the United

States, petitioner claimed that during 1975 and 1976, he

negotiated to sell GMS to Ammareh.    At some point in 1976,

petitioner and Ammareh allegedly orally agreed to the sale for a

price of $8 million, which Ammareh allegedly would pay petitioner

with money earned from the business.    This sale was not evidenced

by any written agreement.    Petitioner did not report the sale on

his 1976 Iranian tax return.

Iran-Iraq War

     War broke out between Iran and Iraq in September 1980 and

lasted until 1988.   Khorramshahr and surrounding areas were

attacked by Iraqi air and ground forces.    The city was captured

by Iraq and was devastated.    GMS’s assets were largely destroyed

as a result of the war.

The “Fair Price Agreement”

     In April 1979, Ammareh traveled to the United States, where

he stayed with petitioners.    Ammareh asked petitioner to sell the

remainder of the business to him or to buy him out.    On April 21,

1979, petitioner handwrote the following statement in Persian (as

translated):

          On April 21, 1979, it was resolved between the
     undersigned that I, Ferydoun Ahadpour, sell all my 50
                              - 7 -
     percent shares [saham], consisting of marine machineries and
     equipment and the storage land of the company [which] is in
     my name and in the name of my children, namely Mr. Bahman
     Ahadpour and Bijan and David Ahadpour, together with my
     personal storage which is presently used by the company to
     Mr. Amarreh at fair price and, as of this date, Mr. Amarreh
     is the owner of Gulf Marine Service Company and the cash and
     accounts receivable, as of this date, belongs to the company
     which exists between us and the contracts which are signed
     as of this date are all the company’s income [and] belong to
     Mr. Amarreh and Mr. Amarreh, taking the God and conscience
     into consideration, purchases the above mentioned shares
     [saham] and pays the price thereof to me.[5] God bless the
     parties.

Both Ammareh and petitioner signed this statement (fair price

agreement).

Statement of Account

     On April 30, 1979, petitioner and Ammareh met with attorney

John Salyer (Mr. Salyer).   Mr. Salyer prepared a document in

English entitled “Statement of Account”.   Mrs. Ahadpour

interpreted between Persian and English during the drafting of

this document.   Both Ammareh and petitioner signed this document,

which states:

          That approximately three (3) years ago, on or about
     1976, in the Country of Iran, FERYDOUN AHADPOUR, DORIS
     AHADPOUR and their dependent children, sold all their right,
     title and interest in and to GULF MARINE SERVICES, * * * to
     HOSSEIN AMMAREH by a separate contract and agreement for the
     amount of Eight (8) Million Dollars ($8,000,000) * * * .
          That Two Million ($2,000,000) dollars of said purchase
     price has been paid by depositing said funds in a bank in
     Iran, and that the remaining balance of Six Million dollars
     ($6,000,000) will be paid by said HOSSEIN AMMAREH in


     5
        According to petitioner’s translation of the document,
the last portion of the sentence reads as “and will pay the price
thereof to me.”
                              - 8 -
     intervals as agreed upon between the parties in the future,
     and all such future payments are to be made by depositing
     the funds in a bank in Iran to the account of FERYDOUN
     AHADPOUR.

     Petitioners testified that they never received the $2

million from Ammareh.    Petitioner stated that he signed the

document based on Ammareh’s oral promise that the funds had been

transferred to a bank.

The Khossravi Appraisal

     Ammareh went back to Iran shortly after signing the fair

price agreement and Statement of Account.    He had GMS’s assets

appraised by Mr. Hajet Khossravi (Mr. Khossravi), who appraised

the assets at 85,600,000 rials (the Khossravi appraisal).6      By

letter dated May 10, 1979, Ammareh forwarded the Khossravi

appraisal to petitioner.

     Before the end of 1979, petitioner and Ammareh had angry

conversations regarding the payment, and Ammareh refused to speak

to petitioner.

Petitioner’s United States Business Endeavors

     In the United States, petitioner primarily became involved

with real estate development and investments.    In 1977,

petitioners formed University Ranches, Inc. (URI).    URI was

solely owned by petitioners, and it engaged in a real estate



     6
        The stipulated annual average exchange rate is 70.48
rials to one dollar. Therefore, under the Khossravi appraisal
the assets were appraised at $1,214,529.
                              - 9 -
transaction with Djamsheed Parsa (Mr. Parsa), a real estate

developer whereby petitioners acquired land for development in

San Diego, California (San Diego project).    Petitioners invested

around $1 million in the San Diego project, and, according to Mr.

Parsa, petitioner told him that the money came from “some company

in Iran”.

       In the 1980's, petitioners acquired Huntington Harbor Bay

and Racquet Club (Huntington Harbor), which was acquired through

URI.

Petitioner’s Collection Efforts in 1980

       In 1980, petitioner hired an Iranian attorney, Dr.

Manouchehr Haghighi (Dr. Haghighi), to contact Ammareh about the

payments.    According to a report prepared by Dr. Haghighi’s

associate dated February 16, 1980, Ammareh was uncooperative and

refused to discuss the matter.

Expropriation Loss Claim

       In 1984, petitioners’ attorneys Michael McCaffrey (Mr.

McCaffrey) and Allen Kroll (Mr. Kroll) researched whether

petitioners could file a claim with the Iranian Claims Tribunal

with respect to their property losses in Iran.    Mr. Kroll

contacted the U.S. Department of State which informed him that

the period of limitations for filing claims with the Iranian

Claims Tribunal had already expired.    Petitioners’ claim was for

the expropriation of a business in Iran.
                              - 10 -
     Petitioners did not file a claim with the Iranian Claims

Tribunal because the Government of Iran did not expropriate GMS

and a dispute between private parties is not heard by the Iranian

Claims Tribunal.

Petitioners’ Balance Sheets in the 1980's

     In the early 1980's, petitioners’ certified public

accountant prepared a list of petitioners’ assets and liabilities

in connection with some estate planning work that he was

conducting for them.   The list did not include a receivable due

from Ammareh or any receivable due from a sale of a business in

Iran.   In 1982, petitioners applied for a personal loan from

Wells Fargo Bank.   Petitioners did not list a receivable due from

the sale of the Iranian business.   In subsequent real estate

applications and statements of financial condition prepared up to

1987, there is no indication of a receivable due from the sale of

an Iranian business.

Petitioners’ Tax Return Preparers

     Petitioner filed a Federal tax return for the first time in

1979.   This joint return was prepared by Douglas Woodward, and

there is nothing on the return to indicate that petitioner sold a

business in that year.

     Petitioners’ 1981 through 1985 tax returns were prepared by

the Brigante & Johnson Accountancy Corp. (Brigante & Johnson).

In 1986, Brigante & Johnson split, and William J. Johnson (Mr.
                              - 11 -
Johnson), one of the partners, formed William J. Johnson &

Associates (Johnson & Associates).   Johnson & Associates retained

petitioners’ account and prepared their tax returns from 1986

through 1991.

     Laura Kauls (Ms. Kauls) was employed as an accountant with

Brigante & Johnson and then with Johnson & Associates.   Ms. Kauls

was responsible for the preparation of petitioners’ tax returns

from 1984 through 1986.

Bad Debt Deduction Inquiry in 1985

     In 1985, petitioner claimed exemption from Federal income

tax withholding on Forms W-4 that he filed with respect to his

businesses (URI and Huntington Harbor).   In December 1985, the

office of the W-4 Technical Unit of the Internal Revenue Service

(IRS) requested additional information as to why petitioner

believed he did not owe any Federal income tax.   Petitioners

forwarded the requests to Ms. Kauls.   Ms. Kauls filled out Form

6450 (Questionnaire To Determine Exemption From Withholding) and

Form 6355 (Worksheet to Determine Withholding Allowances).     Form

6355 indicated that petitioners expected to claim a net loss of

$1 million on Form 4797 (Sale of Business Property) of their 1985

return.   She forwarded these forms to petitioners for their

signature on January 6, 1986.

     Ms. Kauls also filled out a Tax Shelter Questionnaire on

behalf of petitioners to be sent to the IRS.   It is not clear
                              - 12 -
whether this document was sent with the forms mentioned above.

Attached to the Tax Shelter Questionnaire is the following

statement:

     On April 30, 1979, taxpayer sold his business, Gulf Marine
     Services, a construction and salvage company operating
     solely in the country of Iran, for $8,000,000 to an Iranian.
     * * * Two million dollars of said purchase price was
     deposited into a bank in Iran, and the remaining balance of
     six million dollars was to be paid in intervals agreed upon
     between the parties in the future, with all such future
     payments to be deposited in a bank in Iran to the taxpayer’s
     account.

     No payments since the date of sale have been paid, although
     taxpayer has made numerous attempts to make collections on
     this note. However, due to the political and economic
     situation in Iran, it was evident in 1985 that no further
     payments on this note will ever be received by the taxpayer,
     nor will he have access to the funds previously deposited in
     the Iranian bank.

     Consequently, the taxpayer’s loss in the business bad debt
     will decrease his personal income and no Federal income tax
     is expected to be owed for 1985.

     On April 1, 1986, Ms. Kauls sent a copy of the Khossravi

appraisal to the IRS.   On the basis of this appraisal, Ms. Kauls

stated that petitioners were planning on claiming a loss of $1.1

million on their 1985 income tax return.

     In a letter to petitioners dated May 2, 1986, Ms. Kauls

updated petitioners on the status of their 1985 return and

requested further information.   Ms. Kauls additionally stated:

     We will continue to check on the deductibility of the loss
     of your business in Iran (Gulf Marine Services) on your 1985
     tax return. However, as we discussed, you will probably not
     be allowed the deduction due to the fact that it appears you
     sold the business prior to your leaving Iran and becoming a
     U.S. resident.
                               - 13 -

       Ms. Kauls met or had conversations with petitioners numerous

times during 1985 and 1986 with respect to the alleged sale of

GMS.    According to notes that she took during these meetings and

conversations, at one point petitioners told Ms. Kauls that GMS

was not a corporation but a partnership and that Ammareh owned 10

percent.    On another occasion, petitioners told Ms. Kauls that

Mrs. Ahadpour owned 20 percent.    At one time, petitioner stated

that he sold the business in 1976, and on another occasion he

stated that the negotiations started in 1976, but the agreement

was not “drawn up or officially agreed upon until 1979.”

       A bad debt deduction was not claimed on petitioners’ 1985

return.

       Ms. Kauls left Johnson and Associates in 1988.

Collection Efforts

       In 1987, petitioner asked his brother Fariborz Ahadpour

(Fariborz), a legal consultant in Iran, to initiate collection

efforts against Ammareh.    It is not clear whether any collection

efforts took place during 1987 or 1988.    In early 1989, Fariborz

hired Iranian attorney Naghi Izadi (Mr. Izadi) for petitioner.

Petitioner granted a power of attorney to Mr. Izadi to “sue in

civil and penal claims and cases”.

       On April 10, 1989, Mr. Izadi filed a “Legal Notice” with the

Ministry of Justice of the Islamic Republic of Iran.    This notice

was addressed to Ammareh.    In his statement, Mr. Izadi referred
                              - 14 -
to the Statement of Account and provided Ammareh 1 month in which

to pay his debt to petitioner.    If payment was not made, then Mr.

Izadi would take legal action.    Ammareh responded to this notice

and stated that he had owned 50 percent of GMS and that

petitioner sold the remaining 50 percent to him (which was in the

name of petitioner and his sons).    Ammareh also stated that he

had paid petitioner $130,000 for the 50 percent he sold in 1979.

Ammareh finally stated that the Statement of Account was drawn up

so that petitioner could “escape the taxes of the U.S.

government”.7

     On April 25, 1989, Fariborz sent a letter to petitioner

stating that they had to file the claim quickly since the 10-year

period of limitation was running and it has been almost 10 years

since the Statement of Account was signed (April 30, 1979).

Petitioners believed that there was a 10-year period of

limitations for the filing of a lawsuit in pursuit of an unpaid

debt.    Fariborz paid the attorney's fees and requested

reimbursement from petitioner.    Fariborz also detailed what other

attorney's fees and filing fees could be incurred if the suit was

pursued.




     7
        Another translation of this document translates this
phrase as “to present to the authorities”. Respondent does not
agree with this translation.
                              - 15 -
     Petitioner testified that he was unable to pay the fees due

to lack of money, and the civil claim was not pursued any

further.

Pursuit of Criminal Action

     Petitioner asked Fariborz to pursue a criminal action

against Ammareh.   On June 28, 1989, petitioner gave Fariborz a

power of attorney to “consider and administer the Properties of *

* * [petitioner] in Iran, specially Gulf Marine Service Co. Ltd.”

Fariborz retained Mr. Izadi for the criminal prosecution, and

Fariborz signed a power of attorney authorizing Mr. Izadi to take

legal actions with respect to petitioner’s “said properties”.

     On March 26, 1991, Fariborz and Bahman presented a complaint

against Ammareh for a criminal action.    Petitioner testified that

he pursued a criminal action because he wanted to protect his

business reputation in Iran.   In their complaint, Fariborz and

Bahman claimed that they were equity owners of GMS and that

Ammareh, also one of the equity owners, took all the books,

records, and documents belonging to GMS and the other equity

owners, and he had prevented access to them.   They requested

pursuit of the matter and delivery of the books and records.

     On May 26, 1991, petitioner hired two attorneys to pursue

and continue the criminal prosecution of Ammareh.   On December 8,

1991, one of the attorneys, Abdolmajid Zargar (Mr. Zargar), filed

a complaint with the public prosecutor.   In this complaint Mr.
                              - 16 -
Zargar stated that the Statement of Account referred to an

agreement between the parties in 1976 solely for the purpose of

preventing the revolutionary organizations from taking control of

GMS’s property.   Mr. Zargar pleaded that Ammareh be “prosecuted

for misuse of billions of rials of * * * [petitioner’s] assets”.

     On January 16, 1993, Mr. Zargar sent petitioner a letter

summarizing the latest events.   The Tehran Public Prosecutor’s

office released the criminal case file because they thought that

it was more of a civil matter.   The case was transferred to the

Abadan8 Public Prosecutor’s office, where it was examined.    This

office summoned Ammareh to come in and produce his assets, but he

did not comply, and he was arrested and placed in jail.   It is

not clear what next happened with respect to the case.

     In 1996, Bahman filed a declaration with the Ministry of

Justice of the Islamic Republic of Iran to discharge and expel

powers of attorney held by Ammareh with respect to GMS.   The

complaint further directed Ammareh to return all documents

related to GMS within 48 hours of receipt of the complaint.

Ammareh filed a response to the complaint and stated that all

interests, shares, benefits, and ownership of GMS had gradually

been transferred to him.   Therefore, petitioner could not make

any demands of Ammareh since he no longer had any interest in the

business.


     8
         Abadan is a city located near Khorramshahr.
                                - 17 -
Petitioners’ 1989 Return

     Merrietta Fong (Ms. Fong), a certified public accountant

employed by Johnson & Associates, was the preparer of

petitioners’ 1989 tax return.    Ms. Fong was aware of the ongoing

discussion regarding the deductibility of the claimed business

bad debt.   Ms. Fong saw some documentation, but she does not

recall the exact documents.

     Petitioners claimed an $8 million business bad debt

deduction on their 1989 return.    On an attachment to the return

is a statement that the “business bad debt relates to sale of

assets from Gulf Marine Services in prior year.”    The gross sales

price was $8 million with a “cost or other basis” of zero.

     Mr. Johnson signed petitioners’ 1989 return as the preparer.

The $8 million deduction claimed on the 1989 return was his

decision and was based on inquiries and review of the situation

over several years.    Mr. Johnson was told that there was no

longer any ability to collect on the debt because the Iranian

period of limitations had run on collectability.

     Petitioners were out of the country at the time that the

1989 return was due.    Tony Thomas (Mr. Thomas), a certified

public accountant at Johnson & Associates, signed petitioners’

return under a power of attorney.
                              - 18 -
Mailing of the 1989 Return

     Petitioners had been granted extensions to file their 1989

return by October 15, 1990.   On the first Form 4868, Application

for Automatic Extension of Time To File U.S. Individual Income

Tax Return, that was filed, petitioners estimated their total tax

liability to be $3,128.

     Mr. Thomas signed petitioners’ return on October 15, 1990,

before the last returns went to the post office that day.   After

the return was signed, the return went through the firm’s normal

process of going into a batch with other returns that were to be

mailed on that day.

     Johnson & Associates customarily uses a “Tax Routing Sheet”

to route tax returns through the office.   This form indicates

what had been done to the return, by whom, and when.   Ms. Fong

marked her initials and the date in the boxes for “Interviewer”

and “Preparer”.   The tax manager of the tax department marked his

initials and the date in the boxes for “Reviewer” and “Final

return reviewed”.   Mr. Johnson marked his initials and the date

of October 15, 1990, in the box “Return to be signed by”.   The

remaining blocks for “Tax Dept. Log Out”, “Mail to taxpayer”,

“Delivery”, and “Pickup” are blank, and Mr. Thomas stated that

they should have been filled in.
                                - 19 -
       Petitioners’ return is stamped as received by the IRS’s

Fresno, California, office on October 25, 1990.    There is no

evidence of a postmark or receipt for a certified mailing.

Petitioners’ 1990 Return

       Petitioners claimed a net operating loss carryover of

$5,011,913 on their timely filed 1990 return.    This was the

portion of the claimed $8 million loss that was not used in 1989.

The return was signed by Mr. Johnson as preparer.

       Petitioners claimed a deduction of $30,000 for legal fees

and expenses allegedly paid to Fariborz during 1990.    Petitioners

provided documents evidencing the following:    (1) That petitioner

transferred $5,000 (total charge of $5,025 including fees) to

Fariborz’s Iranian bank account (through Melli Bank of Iran in

Los Angeles) on June 15, 1990; and (2) petitioner signed two

checks drawn on the Huntington Harbor account for $5,000 each

payable to Fariborz dated August 20 and November 14, 1990.

       Petitioners did not provide any bills, receipts, or other

documentation which would detail what these amounts were used to

pay.    Mrs. Ahadpour testified that these amounts were for

Fariborz’ expenses in connection with the criminal prosecution of

Ammareh.
                               - 20 -
Petitioners’ 1991 Return

     Petitioners claimed a net operating loss carryover of

$4,755,114 related to the claimed bad debt loss in 1989.    The

return was signed by Mr. Johnson as preparer.

     a. Legal Fees

     Petitioners claimed a deduction of $30,025 for legal fees

and expenses allegedly paid to Fariborz during 1991.    Petitioners

provided documents evidencing:     (1) A transfer from petitioner to

Fariborz’s Iranian bank account of $25,000 ($25,040 with fees)

dated May 25, 1991; and (2) two cashier’s checks to the Melli

Bank of Iran, one for $10,000 dated May 21, 1991, and the other

for $15,000 dated May 23, 1991.9

     Petitioners did not provide any bills or invoices to detail

what these amounts were used to pay.

     b. Filing of the 1991 Return

     Petitioners were granted extensions to file their return on

October 15, 1992.    Petitioners signed their return on October 15,

1992, and the return is stamped “Received” by the IRS on

October 22, 1992.    Petitioners provided a “Domestic Return

Receipt” which shows that the IRS received the return on




     9
        Also provided is a receipt from Wells Fargo Bank showing
that Huntington Harbor sent a cashier’s check to Melli Bank of
Iran and was charged $5,025 on Apr. 15. It is not clear from the
document whether the date is 1990 or 1991, and petitioners could
not recall the actual year.
                                - 21 -
October 20, 1992.    There is no evidence of a postmark or other

evidence of the date the return was mailed.

                             Discussion

Preface

     The record in this case is voluminous, complex, and

confusing, consisting of over 500 exhibits, many of which are in

Persian with attached English translations.    Occasionally, there

are two translations to a document or part thereof, as the

parties could not agree to the translations.    There are hundreds

of pages of testimony and seven expert witness reports.

Evidentiary Issues

     As a preliminary matter, before discussing the bad debt

issue, we must address evidentiary objections raised by the

parties.

     A. Section 982

     Prior to the trial in this case respondent filed four

motions in limine to exclude certain evidence under section 982.

Respondent made a continuing objection under section 982 during

trial, and the Court directed the parties to argue the issue on

brief.    After the trial, respondent withdrew any objections under

section 982.
                              - 22 -
     B. Exhibits 1-P, 13-P, 14-P, and 16-P

     Exhibit 1-P is the declaration with the Ministry of Justice

of the Islamic Republic of Iran to discharge Ammareh’s powers of

attorney.10   Respondent objected on the basis of hearsay.

     Exhibit 16-P is the letter petitioner received from the

Revolutionary Moslem Group in Iran to which respondent objected

on the basis of authenticity, hearsay, and completeness.

     Exhibits 13-P and 14-P are the documents sent to petitioner

by his Iranian attorney in 1980 to which respondent objected on

the basis of completeness, hearsay, and authenticity.

     We overrule respondent’s objections and admit these

documents into evidence.

Petitioners’ Contentions

     Petitioners contend that they should be allowed a bad debt

deduction of $8 million that arose from the sale of GMS in 1976.

Apparently, petitioners argue that GMS was a corporate entity

that was simply an empty shell for estate planning purposes to

which petitioner would eventually transfer his assets and

ultimately distribute them upon his death.

     Petitioners also contend that the Statement of Account

memorialized the 1976 agreement and that they made efforts to



     10
        Respondent also charged that Ammareh’s signature on this
document appeared to be a forgery. The parties agreed to have
the document examined by an expert, though no followup report was
ever submitted. Accordingly, we reject respondent’s charges.
                               - 23 -
collect on the debt.   Petitioners further contend that in 1989

the debt became worthless because the time within which to

collect under the 10-year Iranian period of limitations on

collection of this debt had expired.

Respondent’s Contentions

     Respondent first contends that no sale occurred giving rise

to any debt.   It is respondent’s view that petitioner disposed of

his interest in GMS and was fully paid by Ammareh.    According to

respondent, the alleged $8 million sale was rigged to enable

petitioner to avoid paying American taxes.    Respondent

alternatively contends:

     a.   Any sale between petitioner and Ammareh took place in

1979 after petitioner had established residency in the United

States.   Therefore, petitioner failed to report any gain on the

sale and is limited (if there is a bad debt) to his basis in the

assets (which petitioner has not proven) or in his shares of

stock of GMS (at best $10,000).

     b.   GMS was a corporation owned in part by petitioners and

any sale of the “business” to Ammareh was either at the corporate

level (i.e., GMS sold its business to Ammareh) or a sale of

shares of stock from petitioner to Ammareh.

     c.   Finally, respondent contends that petitioner has failed

to prove when any alleged debt became worthless, arguing that any

such debt had been worthless long before the years at issue.
                              - 24 -
Respondent disputes whether Islamic law (which became more

pronounced after the establishment of Islamic Republic)

recognized the 10-year period of limitations pursuant to the

Iranian Commercial and Civil Codes upon which petitioners claim

they relied.11

     We find it unnecessary to consider all of these contentions

because, even if we viewed the facts most favorably to

petitioners (which we do not), petitioners cannot prevail.

Bad Debt Deduction

     Section 166(a) provides that there shall be allowed as a

deduction any debt which becomes worthless within the taxable

year.     A taxpayer is not entitled to a deduction for a worthless

debt under section 166 in connection with an income item unless

it has been included in the taxpayer’s gross income for Federal

income tax purposes either for the year for which the deduction

is claimed or for a prior year.    See Gertz v. Commissioner, 64

T.C. 598, 600 (1975); Garrison v. Commissioner, T.C. Memo. 1994-

200, affd. without published opinion 67 F.3d 299 (6th Cir. 1995);

sec. 1.166-1(e), Income Tax Regs.    Petitioners never included the

account receivable for the sale of GMS in their income.

Therefore, petitioners are not entitled to a bad debt deduction

because Ammareh defaulted.



     11
        Islamic commentators proclaimed that limiting the time
to make rightful claims is against Islamic principles.
                              - 25 -
     Petitioners claim that this section does not apply to them

since the business was sold in 1976 when they were not residents

of the United States and not required to file a 1976 tax return.

We addressed a similar issue in Antuna v. Commissioner, T.C.

Memo. 1970-290, where we held that the taxpayer was not entitled

to a bad debt deduction resulting from a Cuban expropriation of

an account receivable.   The taxpayer could not establish that he

had previously reported the account receivable as income on

either his Cuban or his U.S. tax return.   In a footnote to this

opinion we stated:

     We need not decide whether inclusion of an item in a foreign
     income tax return furnishes a basis for purposes of the bad
     debt * * * provisions, as does inclusion in a United States
     income tax return. Since petitioner has failed to establish
     the contents of his return, we do not reach this question.
     [Id.]

     Petitioner admitted that the gain (or loss) from the sale of

GMS to Ammareh was not reported on any U.S. or Iranian tax

return.   Therefore, petitioner does not have a basis in the

claimed bad debt.    Accordingly, petitioners are not entitled to a

bad debt deduction for 1989 nor any carryovers of net operating

losses.   Respondent is sustained on this issue.

Deduction of Legal Expenses

     Section 162 allows a deduction for ordinary and necessary

expenses paid or incurred in carrying on a trade or business.

Section 212 allows an individual to deduct all of the ordinary

and necessary expenses paid or incurred in connection with (1)
                              - 26 -
the production of income, (2) the management, conservation, or

maintenance of property held for the production of income, or (3)

the determination, collection, or refund of any tax.    Taxpayers

must keep sufficient records to establish deduction amounts.      See

sec. 6001.

     Whether a litigation expense is deductible depends on the

origin and character of the claim for which the expense was

incurred and whether the claim bears a sufficient nexus to the

taxpayer’s business or income-producing activities.    See Woodward

v. Commissioner, 397 U.S. 572 (1970); United States v. Gilmore,

372 U.S. 39, 44-45 (1963).    Ordinary and necessary litigation

costs are generally deductible under section 162(a) when the

matter giving rise to the costs arises from, or is proximately

related to, a business activity.    See Woodward v. Commissioner,

supra; Kornhauser v. United States, 276 U.S. 145, 153 (1928).

Litigation costs must be “attributable to a trade or business

carried on by the taxpayer” in order to be deductible as a

business expense.   Sec. 62(a)(1); see Guill v. Commissioner, 112

T.C. 325 (1999).

     The ascertainment of a claim’s origin and character is a

factual determination that must be made on the basis of the facts

and circumstances of the litigation.    See United States v.

Gilmore, supra at 47-49.     The most important factor to consider

is the circumstances out of which the litigation arose.    See
                              - 27 -
Guill v. Commissioner, supra; Boagni v. Commissioner, 59 T.C. 708

(1973).   In passing on this factor, the fact finder must take

into account, among other things, the allegations set forth in

the complaint, the issues which arise from the pleadings, the

litigation’s background, nature, and purpose, and the facts

surrounding the controversy.   See Guill v. Commissioner, supra;

Boagni v. Commissioner, supra at 713.

     During 1990 and 1991, petitioners sent $30,000 and $30,025,

respectively, to Fariborz allegedly for legal expenses in

relation to the criminal prosecution of Ammareh.   Petitioners

argue that, although they could no longer pursue a civil action

against Ammareh, they sought criminal prosecution of Ammareh in

order to protect petitioner’s business reputation.   Petitioner

wanted to show that a fraud would not be committed upon him.

Petitioners claim these deductions on their Schedule C for

Huntington Harbor.

     Respondent contends that the legal expenses are not

deductible on petitioners’ Schedule C for Huntington Harbor

because the legal expenses were in pursuit of a criminal matter

and these expenses paid to Fariborz were not ordinary and

necessary expenses of Huntington Harbor nor were they incurred in

the production of income.

     It is not clear whether petitioner was seeking to protect

his business reputation in Iran, in the United States, or both.
                              - 28 -
In any case, we find petitioners’ assertion implausible.

Petitioners have not shown why patrons of Huntington Harbor would

know or care about the pursuit of a criminal prosecution against

Ammareh in Iran.   Petitioners have not demonstrated how the

pursuit of that criminal matter was necessary to protect

petitioner’s business reputation in connection with Huntington

Harbor.   Additionally, it does not appear that petitioner was

going to engage in any future business endeavors in Iran.   Given

the circumstances in the past, it seems doubtful that he would

want to or would be able to do so.

     Accordingly, petitioners are not entitled to deductions for

the legal expenses since they failed to show how these expenses

were necessary to protect petitioner’s business reputation with

respect to Huntington Harbor or any other business undertaking.

Accuracy-Related Penalty

     Section 6662(a) imposes a penalty in an amount equal to 20

percent of the underpayment of tax attributable to one or more of

the items set forth in section 6662(b).   Respondent asserts that

the underpayment of petitioners’ tax was due to negligence or

intentional disregard of rules or regulations, sec. 6662(b)(1),

and to a substantial understatement, sec. 6662(b)(2).

     Petitioners bear the burden of proving that respondent’s

determination is erroneous.   See Rule 142(a); Axelrod v.

Commissioner, 56 T.C. 248, 258-259 (1971).
                              - 29 -
     Negligence includes a failure to make a reasonable attempt

to comply with the provisions of the internal revenue laws.      See

sec. 6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.   Negligence

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

a reasonable person would do under the circumstances.   See

Norgaard v. Commissioner, 939 F.2d 874, 880 (9th Cir. 1991),

affg. in part and revg. in part on other grounds T.C. Memo. 1989-

390; Allen v. Commissioner, 925 F.2d 348, 353 (9th Cir. 1991),

affg. 92 T.C. 1 (1989).   “Disregard” includes any careless,

reckless, or intentional disregard of rules or regulations.      See

sec. 6662(c); sec. 1.6662-3(b)(2), Income Tax Regs.

     There is a substantial understatement of income tax if the

amount of the understatement for the taxable year exceeds the

greater of (1) 10 percent of the tax required to be shown on the

return or (2) $5,000.   See sec. 6662(d)(1)(A).   For purposes of

section 6662(d)(1), “understatement” is defined as the excess of

tax required to be shown on the return over the amount of tax

that is shown on the return reduced by any rebate within the

meaning of section 6211(b)(2).   See sec. 6662(d)(2)(A).   Any

understatement is reduced by the portion of the understatement

attributable to an item for which there is substantial authority

for the treatment by the taxpayer or where the relevant facts

affecting the item’s tax treatment are adequately disclosed in
                              - 30 -
the return or in a statement attached to the return.   See sec.

6662(d)(2)(B).

     The accuracy-related penalty does not apply with respect to

any portion of the underpayment if it is shown that there was

reasonable cause for such portion and that the taxpayer acted in

good faith.   See sec. 6664(c)(1).   The determination of whether a

taxpayer acted with reasonable cause and in good faith depends

upon the pertinent facts and circumstances, including the

taxpayer’s efforts to assess his or her proper tax liability, the

knowledge and experience of the taxpayer, and reliance on the

advice of a professional, such as an accountant.   See sec.

1.6664-4(b)(1), Income Tax Regs.

     Petitioners contend they had a good faith belief that they

were entitled to take the $8 million bad debt deduction on their

1989 tax return based on discussions with their return preparers.

They claim that they relied on the professional advice of the

preparers, and the decision to take the deduction was Mr.

Johnson’s.    Petitioners further contend that they disclosed all

relevant facts to the preparers.

     Generally the duty of filing accurate returns cannot be

avoided by placing the responsibility on a tax return preparer.

See Metra Chem Corp. v. Commissioner, 88 T.C. 654, 662 (1987).

While hiring an attorney or accountant does not insulate the

taxpayer from negligence penalties, good faith reliance on
                              - 31 -
professional advice concerning tax laws is a defense.   See United

States v. Boyle, 469 U.S. 241 (1985); Betson v. Commissioner, 802

F.2d 365, 372 (9th Cir. 1986), affg. in part and revg. in part

T.C. Memo. 1984-264.   Reliance on a qualified adviser may

demonstrate reasonable cause and good faith if the evidence shows

that the taxpayer contacted a competent tax adviser and provided

the adviser with all necessary and relevant information.     See

Collins v. Commissioner, 857 F.2d 1383, 1386 (9th Cir. 1988),

affg. Dister v. Commissioner, T.C. Memo. 1987-217; Jackson v.

Commissioner, 86 T.C. 492, 539-540 (1986), affd. 864 F.2d 1521

(10th Cir. 1989).   In order to prove such reliance, the taxpayer

must establish that the return preparer was supplied with all

necessary information, and the incorrect return was the result of

the preparer’s mistakes.   See Weis v. Commissioner, 94 T.C. 473,

487 (1990).

     Both Ms. Fong, who prepared petitioners’ 1989 return, and

Mr. Johnson, who signed as the tax preparer, believed that

petitioner was the sole proprietor of GMS.   Petitioners told Mr.

Johnson that the period of limitations had run on collectability

of the debt, and they showed him the Statement of Account as

support of the debt.   Mr. Johnson relied on this information

provided by petitioners in determining whether petitioners were

entitled to claim the bad debt.   Mr. Johnson never saw the fair

price agreement, and he testified that if the real agreement
                              - 32 -
between petitioner and Ammareh were the fair price agreement, it

would have changed his decision to claim the deduction on the

return.     Ms. Fong did not recall whether she ever saw the fair

price agreement, but she thought she had seen a note.

     Petitioners had been giving different versions about the

ownership of GMS since 1985 when it was first brought to Ms.

Kauls’ attention for the preparation of their 1985 return.

Petitioners told Ms. Kauls that GMS was a corporation and then

retracted that statement and told her it was a partnership in

which Mr. Ammareh owned 10 percent.12    We note that the latter is

contrary to petitioners’ current position.     At another time,

petitioners told her that Mrs. Ahadpour owned 20 percent of the

business.    It appears that in the end, Ms. Kauls relied on the

Statement of Account and the Khossravi appraisal when she

reported to the IRS that petitioner had sold his business.

     Petitioners have failed to establish that they relied

reasonably and in good faith on any advice given by their

preparers.    Petitioners have not shown that they acted in good

faith and had reasonable cause with respect to the bad debt.      It

is evident that the preparers were aware of the debt only from

the Statement of Account and petitioners’ statements.    Lastly, it

is not clear whether petitioners discussed whether the sale of



     12
        Ms. Kauls left Johnson & Associates in 1988, 2 years
before the 1989 return was filed.
                              - 33 -
GMS had been reported on any prior return.    Petitioners have

failed to show that there was full disclosure.

     Petitioners have failed to carry their burden in proving

good faith reliance on their preparers.   Therefore, we sustain

respondent’s imposition of the accuracy-related penalties for all

years at issue.

Addition to Tax for Delinquency

     Respondent determined that petitioners are liable for each

of the years 1989 and 1991 for the addition to tax under section

6651(a)(1) because they failed to file timely their Federal

income tax return for each year.

     In the case of failure to file an income tax return on the

date prescribed for filing, section 6651(a)(1) imposes an

addition to tax equal to 5 percent of the amount required to be

shown on the return, with an additional 5 percent to be added for

each month or partial month during which such failure continues,

not to exceed 25 percent in the aggregate.

     Petitioners’ 1989 return was due on April 15, 1990, but

petitioners received an automatic 4-month extension through the

filing of Form 4868.   In August 1990, petitioners sought and

received an additional 2-month extension to October 15, 1990,

through the filing of Form 2688.   Petitioners’ return was stamped

as received by the IRS on October 25, 1990.    Petitioners’ 1991

return was due on April 15, 1992, but they filed Forms 4868 and
                              - 34 -
2688 and received the two extensions for a due date of

October 15, 1992.     Petitioners’ return was stamped as received by

the IRS on October 22, 1992.

     Specifically, respondent contends that petitioners failed to

file timely those returns because petitioners’ respective

applications for automatic extension for those years were

invalid; therefore, petitioners are liable for the addition to

tax of the full 25 percent.

     A taxpayer’s application for automatic extension is not

valid if it does not comply with the requirements set forth in

section 1.6081-4(a), Income Tax Regs.     One of the requirements

set forth in that section is that the application must show a

proper estimation of the taxpayer’s tax liability for the taxable

year.     See sec. 1.6081-4(a)(4), Income Tax Regs.   The failure to

estimate properly the final tax liability on Form 4868 can

invalidate the automatic extension and subject the taxpayer to an

addition to tax pursuant to section 6651(a)(1) for failure to

timely file the return.     See Crocker v. Commissioner, 92 T.C.

899, 910 (1989).     Nevertheless, the mere fact that petitioners

underestimated their income tax liability is insufficient to

conclude that the estimate was improper.     See id. at 906.

        A taxpayer will be treated as having “properly estimated”

his tax liability when he or she makes a bona fide and reasonable

estimate of his or her tax liability based on the information
                              - 35 -
available at the time he or she makes the request for an

extension.   Id. at 908.    As a prerequisite for this treatment,

however, the taxpayer must make a bona fide and reasonable

attempt to locate, gather, and consult information which will

enable him or her to make a proper estimate of his or her tax

liability.   See id.

     Petitioners’ taxes were estimated at $3,128 and $8,000 for

1989 and 1991, respectively.    These amounts were estimated by

petitioners’ accountants, and these were the amounts that the

accountants believed to be due for 1989 and 1991.    It is the

taxpayer’s obligation to supply his or her accountant with

complete and accurate records from which to make a reasonable

estimate of tax liability.    See Estate of Duttenhofer v.

Commissioner, 49 T.C. 200, 205 (1967), affd. per curiam 410 F.2d

302 (6th Cir. 1969).

     Petitioners did not provide all of the necessary information

to their accountants in order for them to determine a reasonable

estimate of petitioners’ tax liability.    In the previous section

of this opinion, we held that petitioners were negligent in

claiming the bad debt deduction and that they did not reasonably

rely on the advice of their accountants because they withheld

important information.     It follows that petitioners did not make

a bona fide and reasonable estimate of the tax liabilities by

relying on their accountants.    Thus, we conclude that petitioners
                              - 36 -
did not properly estimate their 1989 and 1991 tax liabilities,

the extension requests were not valid, and the 1989 and 1991

returns were not timely filed.   Therefore, we hold that

petitioners are liable for the additions to tax for delinquency

under section 6651(a)(1) for 1989 and 1991.13

     To reflect the foregoing,

                                         Decision will be entered

                                    under Rule 155.




     13
        The parties also argued whether petitioners’ returns
were timely filed, i.e., postmarked on or before the due dates of
the returns. Because petitioners’ extension requests were not
valid, we need not address this issue.
