                          T.C. Memo. 1997-146



                        UNITED STATES TAX COURT

         CAMILLE D. SANDS, ET AL.,1 Petitioners v. COMMISSIONER
                    OF INTERNAL REVENUE, Respondent




     Docket Nos. 491-94, 888-94,                Filed March 20, 1997.
                 955-94.



     Thomas J. Mitchell, for petitioners.

     Patrick J. Murphy, pro se, in docket No. 955-94.

     Pamela S. Wilson and Elizabeth A. Maresca, for respondent.



                          MEMORANDUM OPINION

     CLAPP, Judge:     Respondent determined the following

deficiencies, additions to tax, and accuracy-related penalties in

petitioners' Federal income taxes:



     1
       Cases of the following petitioners are consolidated
herewith: Kenneth and Maria Heller, docket No. 888-94; and
Patrick J. Murphy, docket No. 955-94.
                                            2

       Camille D. Sands - docket No. 491-94:

                                         Additions to tax
                          Sec.          Sec.         Sec.          Sec.         Sec.
Year       Deficiency   6653(a)(1)    6653(a)(2) 6653(a)(1)(A) 6653(a)(1)(B)    6661
                                           *
1984         $5,935          $297                      --           --         $1,484
                                           *
1985         15,731           787                      --           --          3,933
                                                                    *
1986         27,448            --         --        $1,372                      6,862

__________________
   *
     Fifty percent of the interest due on the portion of the
underpayment attributable to negligence.




       Kenneth and Maria Heller - docket No. 888-94:

                                                  Accuracy-related penalty
                      Year          Deficiency        Sec. 6662(a)

                      1989          $234,141.60        $46,828.32




       Patrick J. Murphy - docket No. 955-94:

                                                  Accuracy-related penalty
                      Year          Deficiency        Sec. 6662(a)

                      1989          $329,292.97        $65,858.59



       Respondent also determined that petitioners are liable for

increased interest pursuant to section 6621(c) (formerly

6621(d))2 for each of the taxable years in issue.


       2
      Sec. 6621(d) was redesignated as sec. 6621(c) by sec.
1511(c)(1)(A) of the Tax Reform Act of 1986, Pub. L. 99-514, 100
Stat. 2085, 2744, and repealed by sec. 7721(b) of the Omnibus
Budget Reconciliation Act of 1989 (OBRA 89), Pub. L. 101-239, 103
Stat. 2106, 2399, effective for tax returns due after Dec. 31,
1989, OBRA 89 sec. 7721(d), 103 Stat. 2400. For convenience, we
                                                   (continued...)
                                   3

     The issues for decision are:

     (1)   Whether petitioner Sands is entitled to deductions

related to Lone Star Associates (Lone Star), a partnership.      We

hold that she is to the extent stated herein.

     (2)   Whether, pursuant to the doctrines of res judicata or

collateral estoppel, respondent must offer petitioner Sands a

settlement for the taxable years 1984, 1985, and 1986 analogous

to the settlement between petitioner Murphy and respondent for

the taxable years 1985 and 1986.       We hold that respondent is not

required to offer Sands the settlement.

     (3)   Whether Lone Star received $258,968 from Electro in

cancellation of a lease.   We hold that it did not.

     (4)   Whether Lone Star recognized income when it was

released from a debt obligation.       We hold that it did.

     (5)   Whether, in 1989, petitioner Murphy owned a 9.53-

percent interest or a 50-percent interest in Lone Star.       We hold

that Murphy owned a 9.53-percent interest in Lone Star in 1989.

     (6)   Whether petitioners are liable for increased interest

under section 6621.   We hold that they are not.

     (7)   Whether petitioner Sands is liable for additions to tax

for negligence under section 6653(a)(1) and (2) for the taxable



     2
      (...continued)
refer to this section as sec. 6621(c). The annual rate of
interest under sec. 6621(c) for interest accruing after Dec. 31,
1984, equals 120 percent of the interest payable under sec. 6601
with respect to any substantial underpayment attributable to tax-
motivated transactions.
                                 4

years 1984 and 1985, and under section 6653(a)(1)(A) and (B) for

the taxable year 1986.   We hold that she is not.

     (8)   Whether petitioner Sands is liable for an addition to

tax under section 6661 for a substantial understatement of tax

for each of the taxable years 1984, 1985, and 1986.   We hold that

she is.

     (9)   Whether petitioners Heller and Murphy are liable for an

accuracy-related penalty for a substantial understatement of

income tax under section 6662 for the taxable year 1989.    We hold

that they are.

     All section references are to the Internal Revenue Code in

effect for the years in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure, unless otherwise

indicated.

     We have combined our findings of fact and opinion.    Some of

the facts are stipulated and are so found.   We incorporate by

reference the stipulation of facts and attached exhibits.

     At the time the petitions were filed, Kenneth and Maria

Heller and Camille D. Sands (Sands) resided in New York, New

York, and Patrick J. Murphy (Murphy) resided in Brooklyn, New

York.   Murphy, an attorney, was the only witness at trial.

     These cases relate to Lone Star in which Sands, Kenneth

Heller (Heller), and Murphy were each general partners.

Respondent determined deficiencies as to Sands for the taxable

years 1984, 1985, and 1986 on the theory that the deductions
                                  5

taken by Lone Star should be disallowed.    Respondent determined

deficiencies as to Heller and Murphy for the taxable year 1989 on

the theory that Lone Star recognized income when it was released

from a debt obligation.

A.   Background

     In 1983, Murphy represented Micro-Bio (Ireland) Ltd. (Micro-

Bio), a corporation formed under the laws of Ireland, in the

acquisition of a chlor-alkali system, a system which produces

chlorine.   Murphy traveled to Arizona with Micro-Bio executives

to see a chlor-alkali system in use.    Micro-Bio executives liked

what they saw and decided to purchase a chlor-alkali system from

Eltech, Ltd. (Eltech), the manufacturer of the chlor-alkali

system.

     On August 8, 1983, Micro-Bio entered into a letter agreement

with Eltech in which Micro-Bio agreed to purchase the chlor-

alkali system.    The relevant terms of the letter agreement

include the following:    (1) A lease period of 5 years with

interest calculated on the complete contract amount from the

shipment date of the equipment; (2) payments were to commence 30

days after plant startup and were to continue for 59 consecutive

months; (3) the equipment passed to Micro-Bio after the 5-year

lease period; (4) the equipment remained the property of Eltech

at all times throughout the 5-year lease period; (5) Micro-Bio

had the option to obtain a third-party lease or financing subject

to Eltech's approval; (6) Micro-Bio would insure the equipment;
                                 6

and (7) Micro-Bio would pay a fee for any technical assistance

provided by Eltech during the lease period.

     No purchase price was set forth in the letter agreement, but

the parties agree that the purchase price due Eltech from Micro-

Bio for the chlor-alkali system was $2,121,798.   The letter

agreement purports to be a lease between Eltech and Micro-Bio;

however, we find that the terms of the transaction constitute a

sale in which Eltech retained a security interest.    See generally

Bowen v. Commissioner, 12 T.C. 446, 459-460 (1949).

     The letter agreement provided that the conditions set forth

therein "together with ELTECH's other required lease conditions"

shall be formalized in a lease document entered into between

Eltech and Micro-Bio.   No such lease document has been made part

of the record.   Based on Murphy's description of the transactions

and from other documents that incorporate by reference the

September 1983 agreement, we find that Eltech and Micro-Bio did

enter into an agreement in September 1983 (September 1983

agreement) in which Micro-Bio agreed to purchase the chlor-alkali

system from Eltech for a purchase price of $2,121,798.   Eltech

financed the purchase with a nonrecourse debt of $2,121,798.    The

record does not state whether the debt was recourse or

nonrecourse.   We find for purposes of this opinion that the debt

was nonrecourse, since there apparently was no attempt by Eltech

to recover from Lone Star or the general partners personally

after Lone Star assumed Micro-Bio's obligations to Eltech (as
                                 7

noted infra).   A principal payment of $338,950.86 was due in the

first year, and principal payments of $445,711.80 were due in

each of years 2 through 5.   No evidence shows the interest due on

the unpaid principal balance.

     Micro-Bio never completed the purchase.   Micro-Bio preferred

to lease the chlor-alkali system rather than purchase it.    Murphy

saw this as an opportunity, and he formed Lone Star, a general

partnership, to purchase the chlor-alkali system from Eltech and

then lease the system to Electro Systems (Electro), a subsidiary

of Micro-Bio.   Sands, Heller, Murphy, and two other individuals

not involved in these cases, Miller and Wiener, were partners in

Lone Star.   Murphy managed Lone Star, and Lone Star intended to

profit from the venture.   Each partner's distributive share of

income, gain, loss, deduction, or credit was made in accordance

with the partner's interest in the partnership.

     On September 20, 1983, Micro-Bio and Lone Star entered into

an agreement (Micro-Bio/Lone Star agreement) whereby Micro-Bio

sold to Lone Star the contract rights to acquire the chlor-alkali

system from Eltech pursuant to the September 1983 agreement.

Lone Star paid Micro-Bio $500,000 for Micro-Bio's contract

rights, and Lone Star assumed Micro-Bio's obligations to Eltech.

     The Micro-Bio/Lone Star agreement also provided that Micro-

Bio would lease the chlor-alkali system from Lone Star for 5

years (Micro-Bio/Lone Star lease agreement).   Payments under the

Micro-Bio/Lone Star lease agreement consisted of $338,950.86 for
                                   8

year 1, and $445,711.80 in each of years 2 through 5, plus a

further payment by Micro-Bio to Lone Star of $140,000 per annum

over the 5-year period.    At the end of the 5-year lease period,

Micro-Bio could purchase the chlor-alkali system from Lone Star

for $500,000, or Micro-Bio could lease the system for the next

succeeding 5 years for $140,000 per annum.

     Lone Star entered into a lease agreement with Miro-Bio's

subsidiary, Electro (Lone Star-Electro lease), in which Lone Star

agreed to lease the chlor-alkali system to Electro.       The Loan

Star-Electro lease is not dated.       The Lone Star-Electro lease

provided for monthly payments of $19,349.16 for the first 6

months and $37,142.65 for the following 54 months, for total

payments of $2,121,798.06.

     Around May 1984, Electro installed and put into service the

chlor-alkali system.    Problems plagued Electro's operation of the

chlor-alkali system, and it never operated properly.       In 1984,

Electro stopped making rental payments to Lone Star under the

Lone Star-Electro lease, and in turn, Lone Star stopped making

payments to Eltech.    Lone Star depreciated the chlor-alkali

system in the taxable years 1984, 1985, and 1986 and passed the

depreciation deductions through to its partners.

     The poor operation of the chlor-alkali system led to

disputes between Lone Star, Eltech, Micro-Bio, and Electro.

These disputes were settled in 1989.
                                     9

     Under the terms of the settlement, Eltech forgave and

canceled payment of the $2,069,656 balance due from Lone Star.

At the time of the settlement, Lone Star's adjusted basis in the

chlor-alkali system was $1,019,104 ($2,621,798 cost basis less

$1,602,694 of depreciation deductions).    At the direction of

Eltech, Lone Star, "as beneficial owner", transferred full

ownership of the chlor-alkali system to Electro and agreed to

relieve Electro of all obligations under the Lone Star-Electro

lease.    Electro agreed to pay Lone Star some amount, which was

determined by respondent to be $258,986, but Electro never

fulfilled that obligation.

B.   Petitioner Sands

     Respondent argues that Sands deducted amounts in excess of

her distributive shares of the partnership items.    Sands owned a

5-percent, 7-percent, and 7.5-percent partnership interest in

Lone Star during the taxable years 1984, 1985, and 1986,

respectively, and her distributive share of the partnership items

for each taxable year is limited accordingly.

     1.    Depreciation Deductions

     Respondent argues that Sands is not entitled to depreciation

deductions, because the chlor-alkali system was never placed in

service.    Electro installed and operated the chlor-alkali system

in 1984, and we find that the system was placed in service at

that time.    We recognize that problems plagued the system's
                                 10

operation, but those problems were not so severe as to prevent

the system from being placed in service.

     Respondent argues that we should disregard Lone Star's

$2,621,798 cost basis in the system, because there were no arm's-

length negotiations over the purchase price.    To support this

argument, respondent notes that Murphy served as legal counsel

for Micro-Bio when Micro-Bio acquired the chlor-alkali system

technology from Eltech.    There is no evidence that Murphy

influenced the terms of the transaction between Micro-Bio and

Eltech.   Before Lone Star agreed to purchase the chlor-alkali

system from Eltech, Murphy reviewed financial projections

prepared by Micro-Bio.    After reviewing the information at his

disposal, Murphy concluded that the purchase of the chlor-alkali

system was a sound investment.    While the matter is not free from

doubt, we find that Lone Star acquired the chlor-alkali system in

an arm's-length transaction.

     Sands is entitled to her share of the Lone Star depreciation

deduction in each of the taxable years 1984, 1985, and 1986 based

on the foregoing facts.

     2.   Interest Deductions and Other Deductions

     Lone Star reported interest expenses of $70,360 and $48,786

for taxable years 1984 and 1985, respectively.    Lone Star

reported "other deductions" of $19,227 and $38,612 for taxable

years 1984 and 1986, respectively.    Sands deducted her

proportionate shares of these items, and respondent disallowed
                                  11

these deductions.     Sands offered no evidence to substantiate that

Lone Star paid the amounts in dispute.     Sands submitted a payment

notice addressed to her showing interest due on a loan in which

she was the borrower.     Petitioners submitted two other statements

showing interest paid on a loan to Kips Bay Associates, an entity

that Murphy described as an investment of his.     There is no

evidence that the interest amounts shown on the loan statements

were Lone Star's obligations or that Lone Star paid those

amounts.     There is no evidence that Lone Star paid the "other

deductions" during the years in issue.     We sustain respondent's

determination as to these items.

     3.     Application of Res Judicata or Collateral Estoppel

     Sands argues that the terms of two settlements entered into

between Murphy and respondent should apply to her as well.       Sands

argues that the doctrines of collateral estoppel and res judicata

bind respondent to this result.     We do not agree.

     Sands rests her argument on two cases filed by Murphy, which

involved Murphy's taxable years 1985 and 1986:     Murphy v.

Commissioner, docket No. 4949-91, and Murphy v. Commissioner,

docket No. 5150-91 (docket Nos. 4949-91 and 5150-91).     Those

cases involved Murphy's deductions associated with Lone Star.

Those cases were never tried, and Sands was not a party in either

case.     Murphy and respondent settled those cases and agreed that

no deficiencies in income taxes were due and that no addition to

tax under section 6651(a) was due for each of Murphy's taxable
                                12

years 1985 and 1986.   This Court entered a stipulated decision in

each case.

     Collateral estoppel and res judicata protect litigants from

the burden of relitigating an identical issue and promote

judicial economy by preventing redundant litigation.    Under the

doctrine of collateral estoppel, or issue preclusion, the

judgment in a prior lawsuit precludes, in the second cause of

action, litigation of issues actually litigated and necessary to

the outcome of the first action.     Parklane Hosiery Co. v. Shore,

439 U.S. 322, 326 (1979).   The doctrine of res judicata, or claim

preclusion, precludes a party to a suit and its privies from

again litigating a cause of action in which a court of competent

jurisdiction has entered a final judgment on the merits.    Meier

v. Commissioner, 91 T.C. 273, 282 (1988).    For res judicata to

apply, the party invoking the doctrine must show: (1) The cause

of action in the prior case is the same cause of action as in the

instant case; (2) petitioner qualifies as a party or a privy of a

party in the prior case; and (3) there was a final judgment on

the merits in the prior case.   Commissioner v. Sunnen, 333 U.S.

591, 597 (1948); Kroh v. Commissioner, 98 T.C. 383, 398-399

(1992).

     We have not decided the correctness of respondent's

determinations for Murphy's taxable years 1985 and 1986.    This

Court held no trial, received no evidence, and made no finding of

fact.   Murphy and respondent disposed of docket Nos. 4949-91 and
                                  13

5150-91 through settlement.   The stipulated decisions in docket

Nos. 4949-91 and 5150-91 were only a pro forma acceptance of an

agreement between Murphy and respondent.     See United States v.

International Bldg. Co., 345 U.S. 502, 506 (1953).     The

stipulated decisions do not indicate the reason for the

settlement.   Moreover, litigants generally arrive at settlement

by mutual give and take.   Petitioner Sands and respondent are

litigating the issues of this case for the first time.

Furthermore, a partner solely by reason of the partnership

relationship generally is not privy with the other partners,

since one partner's interest is not derived from another partner

but is an independent interest.      Mathisen v. Commissioner, 22

T.C. 995, 998 (1954).   It is Sands' tax liabilities, not

Murphy's, that are being asserted against her.     The doctrines of

collateral estoppel and res judicata are inapplicable here.

C.   Petitioners Murphy and Heller

     1. Lone Star's Income in Taxable Year 1989 From the
Settlement With Electro

      Respondent determined that Lone Star received $258,986 of

taxable income from Electro in 1989.     To support this

determination, respondent relies on the following:     Lone Star's

settlement agreement with Electro, a handwritten worksheet

attached to Lone Star's U.S. Partnership Return of Income (Form

1065) for the taxable year 1989, and a letter dated June 1, 1990,

from Murphy to Internal Revenue Service agent Ronald Sherman

(Sherman).
                                   14

     In the settlement agreement between Lone Star and Electro,

Electro agreed to pay Lone Star the sum of $390,000.         Murphy

signed an affidavit dated September 11, 1992 (affidavit), when he

settled docket Nos. 4949-91 and 5150-91 with respondent.         In the

affidavit Murphy stated:      "The settlement provided that Electro

would make a payment of $258,986.00 to * * * [Lone Star] and

* * * [Lone Star] would relieve Electro of all obligations under

the Lease."    Murphy testified that Lone Star did not receive

payment from Eltech pursuant to the settlement.

     Lone Star's Form 1065 for the taxable year 1989, dated

October 15, 1990, includes one income item under "Other income"

in the amount of $3,176.      A handwritten worksheet is attached to

the 1989 Form 1065 with the following notations:



                 1989

     Lone Star/Sale of Rights
     Receipts - cash      $258,986
     forgiven - Debt     2,069,656
                                               $2,328,642
     less
            Rights released       1,639,600
                                    750,000     $2,389,600
                                       loss       (60,958)
                                       interest

Murphy testified that he inadvertently attached the worksheet to

Lone Star's 1989 Form 1065.     He testified that he prepared

several worksheets, and this one related to the possibility of

discounting, for $258,968, Electro's obligation to pay Lone Star

$390,000.    Lone Star pursued none of these alternatives.
                                 15

     In a letter to Sherman dated June 1, 1990, Murphy stated,

"Please be advised that * * * [Lone Star's] 1989 Form 1065 will

reflect receipt of $275,000 received as income in partial

settlement of its claims."

     We find that Lone Star did not receive $258,986 from Electro

in 1989.    The items highlighted by respondent indicate that

Murphy may have intended to collect a payment from Electro

pursuant to the 1989 settlement agreement, but we find that no

such payment occurred in 1989.

     2.    Lone Star's Disposition of the Chlor-Alkali System

     Petitioners concede that Eltech forgave the debt in the

amount of $2,069,656 due from Lone Star.    Petitioners argue that

this amount does not constitute income in 1989 because (1) the

debt was forgiven in 1987, and (2) the debt reduction qualifies

as a price reduction pursuant to section 108(e)(5).

     Petitioners' contention that the discharge of indebtedness

occurred in 1987 directly contradicts Murphy's affidavit, which

provides that in 1989 Electro, Micro-Bio, and Eltech settled all

their disputes arising from Lone Star's purchase of the chlor-

alkali system.    The affidavit provides that Eltech relieved Lone

Star of its obligation to pay $2,069,656.    We sustain

respondent's determination that the discharge of indebtedness in

the amount of $2,069,656 occurred in 1989.

     We further conclude that the discharge of debt by Eltech and

Lone Star's release of its ownership in the chlor-alkali system
                                  16

constitutes a sale or exchange.    See Yarbro v. Commissioner, 737

F.2d 479, 483-484 (5th Cir. 1984), affg. T.C. Memo. 1982-675;

Gershkowitz v. Commissioner, 88 T.C. 984, 1016 (1987); Estate of

Delman v. Commissioner, 73 T.C. 15, 33 (1979).     We reach this

conclusion for several reasons.    First, Eltech's discharge of the

debt and Lone Star's release of ownership in the chlor-alkali

system were part of one settlement.    Second, we find that as part

of the settlement, Eltech directed Lone Star to transfer

ownership of the chlor-alkali system to Electro rather than have

those rights transferred back to Eltech.    Third, we find

incredible the contention that Eltech forgave over $2 million in

debt owed by Lone Star, while at the same time letting Lone Star

retain some ownership rights in the chlor-alkali system, and then

in a "separate and distinct" transaction, Lone Star transferred

its ownership rights in the chlor-alkali system to Electro.    We

find that Eltech's discharge of the debt and Lone Star's transfer

of its ownership rights were part of a single transaction.    Lone

Star must recognize as gain the excess of the amount of debt

forgiven over the adjusted basis of the chlor-alkali system.

Secs. 61(a)(3), 1001(a); sec. 1.1001-2(a)(1), Income Tax Regs.

Lone Star's partners must take into account their distributive

shares of such gain.   Sec. 702(a).    As for petitioners' argument

under section 108(e)(5), that section is not applicable to gains

derived from dealings in property.     Gershkowitz v. Commissioner,

supra.
                                    17

     3.   Murphy's Percentage Ownership of Lone Star in 1989

     Lone Star's Schedules K-1, Partner's Share of Income,

Credits, Deductions, Etc. (K-1), attached to the Forms 1065 show

the following partners and ownership percentages in Lone Star:

                       1984        1985      1986      1989

     Sands               5          7        7.5        --

     Heller              50         50       50         50

     Murphy              15         15       9.32       50

     Miller              15         15       15         --

     Wiener              15         18.18    18.18      --

             Total      100        105.18   100        100

Lone Star's 1988 Form 1065 indicates that Lone Star consisted of

five partners and that the partnership had no activity in 1988.

There are no K-1's attached to Lone Star's 1988 Form 1065.       If

there was a 1987 Form 1065, it is not part of the record.

     Murphy argues that he did not own 50 percent of Lone Star in

1989 and that amounts received by Lone Star in 1989 should be

allocated to all five partners according to the 1986 ownership

percentages.     We agree.    By 1989, Lone Star was settling its

disputes with Eltech, Electro, and/or Micro-Bio.       We find that

the ownership interests for the taxable year 1989 are the same as

the ownership interests shown on Lone Star's 1986 Form 1065.

Murphy intended the 1989 K-1's to reflect that he and Heller were

the only partners with any active involvement in Lone Star during

1989, and their involvement stemmed from the ongoing dispute with
                                 18

respondent.    Murphy's filing of an erroneous K-1 in 1989 does not

alter the ownership interests in Lone Star.

D.   Increased Interest, Additions to Tax, and Penalty

      1.   Increased Interest Pursuant to Section 6621

      Respondent determined that petitioners are liable for

increased interest under section 6621 with respect to the

underpayments for Sands' taxable years 1984, 1985 and 1986, and

for Heller's and Murphy's taxable year 1989.    Section 6621

provides for an increase in the interest rate to 120 percent of

the statutory rate on the underpayments of tax if a substantial

understatement is due to a tax-motivated transaction.    Respondent

argues that the underpayments are due to a tax-motivated

transaction, because Lone Star's purchase of the chlor-alkali

system was not a transaction entered into for profit.    See

Clayden v. Commissioner, 90 T.C. 656, 677 (1988).

      As for Heller and Murphy, the increased rate of interest

under section 6621(c) is inapplicable.   Section 6621(c) was

repealed by sec. 7721(b) of the Omnibus Budget Reconciliation Act

of 1989 (OBRA 89), Pub. L. 101-239, 103 Stat. 2106, 2399,

effective for tax returns due after December 31, 1989.    OBRA 89

sec. 7721(d), 103 Stat. 2400.    Murphy's tax return and Heller's

tax return for the taxable year 1989 were due after that date.

Sec. 6072(a).    As for Sands, Murphy served as legal counsel for

Micro-Bio when Micro-Bio executives traveled to Arizona to see

one of Eltech's chlor-alkali systems in operation.    Before Lone
                                  19

Star agreed to purchase the chlor-alkali system from Eltech,

Murphy reviewed financial projections prepared by Micro-Bio.

Based on this information, Murphy concluded that the purchase of

the chlor-alkali system was a sound investment for Lone Star.

Technical problems after installation sapped the chlor-alkali

system of its profit potential.    We find section 6621(c)

inapplicable under these circumstances.

     2.   Additions to Tax for Negligence

     Respondent determined that Sands is liable for additions to

tax for negligence under section 6653(a)(1) and (2) for the

taxable years 1984 and 1985 and section 6653(a)(1)(A) and (B) for

the taxable year 1986.   Section 6653(a)(1) imposes an addition to

tax equal to 5 percent of the underpayment of tax if any part of

the underpayment is due to negligence or intentional disregard of

rules or regulations.    Section 6653(a)(2) imposes an addition to

tax equal to 50 percent of the interest payable on the portion of

the underpayment that is attributable to negligence.    For 1986,

section 6653(a)(1)(A) imposes an addition to tax equal to 5

percent of the underpayment if any part of the underpayment is

attributable to negligence, and section 6653(a)(1)(B) imposes an

addition to tax equal to 50 percent of the interest payable on

the portion of the underpayment that is attributable to

negligence.

     Negligence is defined as the lack of due care or the failure

to do what a prudent person would do under the circumstances.
                                 20

Marcello v. Commissioner, 380 F.2d 499, 506 (5th Cir. 1967),

affg. in part and remanding in part 43 T.C. 168 (1964); Neely v.

Commissioner, 85 T.C. 934, 937 (1985).    Sands must establish that

the negligence additions to tax do not apply. Bixby v.

Commissioner, 58 T.C. 757, 791 (1972).

       Sands' underpayments stem from her inability to

substantiate Lone Star's expenses.    Failing to keep or produce

adequate books and records, as required by section 6001, may be

justification for imposing the negligence additions to tax.

Axelrod v. Commissioner, 56 T.C. 248, 258-259 (1971); Zafiratos

v. Commissioner, T.C. Memo. 1992-135, affd. without published

opinion 993 F.2d 880 (3d Cir. 1993).    We find that Sands is not

liable for additions to tax for negligence for the taxable years

1984, 1985, or 1986.    Sands played a minimal role in Lone Star's

activities.   She relied on Murphy to manage Lone Star and to keep

adequate records to substantiate Lone Star's expenses.    Sands had

no control over these matters.   See Antonides v. Commissioner, 91

T.C. 686, 700 (1988), affd. 893 F.2d 656 (4th Cir. 1990).

     3. Substantial Understatement Addition to Tax and Accuracy-
Related Penalty

     Respondent determined an addition to tax under section 6661

against Sands for each of the taxable years 1984, 1985, and 1986.

Section 6661(a) imposes an addition to tax equal to 25 percent of

the amount of any underpayment attributable to a substantial

understatement of income tax.    Pallottini v. Commissioner, 90

T.C. 498, 503 (1988).   An understatement exists where the amount
                                 21

of tax shown on the taxpayer's return is less than the amount

required to be shown on the return.     Sec. 6661(b)(2)(A).   In the

case of individuals, an understatement is substantial if it

exceeds the greater of $5,000 or 10 percent of the tax required

to be shown.    Sec. 6661(b)(1)(A).   The amount of the

understatement may be reduced under section 6661(b)(2)(B) for

amounts adequately disclosed or supported by substantial

authority.    Respondent's determination of the addition to tax is

presumed correct, and petitioner must prove otherwise. Rule

142(a); Hall v. Commissioner, 729 F.2d 632, 635 (9th Cir. 1984),

affg. T.C. Memo. 1982-337; Bixby v. Commissioner, supra at 791-

792.

       Respondent determined that petitioners Heller and Murphy are

liable for an accuracy-related penalty for a substantial

understatement of income tax under section 6662 for the entire

underpayments for their 1989 taxable year.     Section 6662(a)

imposes a penalty equal to 20 percent of the portion of the

underpayment that is attributable to a substantial understatement

of income tax.

       Petitioners argue that substantial authority supports their

respective positions.    Substantial authority exists for the tax

treatment of an item only if the weight of the authorities

supporting the treatment is substantial in relation to the weight

of the authorities supporting contrary positions.     Accardo v.

Commissioner, 942 F.2d 444, 453 (7th. Cir. 1991), affg. 94 T.C.
                                 22

96 (1990);   Cramer v. Commissioner, 101 T.C. 225, 255 (1993),

affd. 64 F.3d 1406 (9th Cir. 1995); sec. 1.6661-3(b), Income Tax

Regs.   In light of our discussion above, we conclude that the

authorities relied on by petitioners did not constitute

substantial authority.

     Accordingly, if recomputation of petitioners' tax

liabilities reflects a substantial understatement, petitioner

Sands is liable for the addition to tax, and petitioners Heller

and Murphy are liable for the penalty.

     To reflect the foregoing,

                                           Decisions will be entered

                                      under Rule 155.
