                       T.C. Memo. 2001-219



                     UNITED STATES TAX COURT



 JOHN NORMAN FAVERO AND PATRICIA CAROLYN FAVERO, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 10427-99.                    Filed August 13, 2001.


     John Norman Favero and Patricia Carolyn Favero, pro sese.

     Roger W. Bracken, for respondent.



                       MEMORANDUM OPINION


     DEAN, Special Trial Judge:   Respondent determined

deficiencies of $3,154, $3,881, and $6,723 in petitioners’

Federal income taxes for taxable years 1995, 1996, and 1997,1



     1
        The statutory notice of deficiency for 1997 pertains only
to petitioner John Favero (Mr. Favero). Petitioners filed
jointly their Federal income tax returns for 1995 and 1996, but
Mr. Favero filed separately for 1997.
                               - 2 -

respectively.   In addition, respondent determined accuracy-

related penalties under section 6662(a)2 of $630.80, $776.20, and

$1,344.60 for taxable years 1995, 1996, and 1997, respectively.

     After concessions,3 the issues for decision are:   (1)

Whether petitioners may exclude from gross income the amounts

petitioner John Favero (Mr. Favero) received as compensation in

1996 and 1997 working as a merchant seaman for various U.S.

corporations and/or businesses as either combat zone compensation

or foreign earned income; (2) whether petitioners are entitled to

deduct expenses on Schedule C, Profit or Loss From Business, of

$12,087 in 1995; (3) whether petitioners are entitled to deduct

expenses on Schedule E, Supplemental Income and Loss, beyond

those allowed by respondent in 1995 and 1996; (4) whether


     2
        Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the years in issue.
     3
        Petitioners concede that they are not entitled to a
capital loss in 1995, they are not entitled to deductions for
moving expenses in 1995 or 1996, and they are not entitled to the
mortgage interest expense deductions of $2,000 and $1,800 claimed
as itemized deductions in 1995 and 1996, respectively. Mr.
Favero concedes that he is not entitled to expenses, other than a
mortgage interest expense of $1,459, claimed as deductions on
Schedule E of his 1997 return; he is not entitled to the mortgage
interest expense deduction of $1,800 claimed as an itemized
deduction in 1997; and he is not entitled to the real estate tax
deduction of $500 claimed as an itemized deduction on his 1997
return. Petitioners concede that Mr. Favero received
unemployment compensation of $3,003 in 1995 and that Mrs. Favero
received Social Security payments of $5,247 in 1995 and $5,890 in
1996. Other adjustments in the notices of deficiency are
computational adjustments to petitioners’ itemized deductions
based on respondent’s other adjustments. These computational
adjustments are not contested and therefore not before the Court.
                                - 3 -

petitioners may file a joint return after filing separate returns

for the 1997 tax year; and (5) whether petitioners are liable for

the accuracy-related penalty under section 6662(a) for 1995,

1996, and 1997.

                             Background

     The stipulation of facts and the accompanying exhibits are

incorporated herein by reference.   Petitioners resided in

Virginia Beach, Virginia, at the time their petition was filed

with the Court.

     Petitioners are a married couple who filed joint Federal

income tax returns for tax years 1995 and 1996.   Petitioners,

however, filed 1997 returns separately.   Petitioner Patricia

Favero’s (Mrs. Favero) 1997 return is not in issue in this case.

Since December 31, 1994, petitioners have been citizens and

residents of the United States.

     During the years in issue, Mr. Favero was employed by U.S.

corporations and/or businesses as a sailor on board merchant

ships.   He was a member of the Seafarers International Union

(SIU) and received his ship assignments from the union hall

located in Norfolk, Virginia.   The headquarters of SIU is located

in Camp Springs, Maryland.   Mr. Favero has not filed any tax

returns for any tax period since December 31, 1994, with any

foreign country, nor has he paid tax to any foreign country.
                               - 4 -

     Mr. Favero filed Forms 1116, Foreign Tax Credit, with his

1995, 1996, and 1997 tax returns and claimed foreign tax credits

in the approximate amount of the wages he earned as a merchant

seaman.4   In 1996 and 1997, Mr. Favero claimed foreign earned

income exclusions for the approximate amount of wages he earned

as a merchant seaman.

     In 1995, petitioners filed a Schedule C claiming a loss of

$13,210.   The principal business listed on the Schedule C is

“Other Apparel + Accessory Stores”.    No income was reported from

the business.   In 1995 and 1996, petitioners filed Schedules E

reporting net losses of $1,420 in 1995 and $2,870 in 1996 from

the rental of real estate.

     Respondent determined petitioners are not entitled to

foreign earned income exclusions for the years in issue and

disallowed $12,087 of the Schedule C deduction petitioners

claimed in 1995.   Respondent also disallowed the following

expenses petitioners claimed on their Schedules E:   (1) Auto and

travel expenses of $2,000 in 1995 and $1,500 in 1996; (2) an

insurance expense of $2,000 in 1996; and (3) mortgage interest

expenses of $388 in 1995 and $244 in 1996.



     4
        Because petitioners had taxable income of zero after
claiming itemized deductions and exemptions for each of the 3
years, they were unable to use the foreign tax credit to offset
their U.S. income tax liability. Respondent, therefore, made no
adjustments in the notices of deficiency for the foreign tax
credits petitioners claimed.
                               - 5 -

     Petitioners argue that they are entitled to exclude Mr.

Favero’s wages as combat zone compensation or as foreign earned

income.   They also argue that they are entitled to Schedule C

deductions for Mrs. Favero’s “cottage industries”.

                            Discussion

     Gross income includes all income from whatever source

derived unless otherwise specifically excluded.    Sec. 61(a).

Section 112 provides that certain compensation received by

members of the Armed Forces of the United States serving in

combat zones or hospitalized as a result of injuries received in

such zones shall not be included in gross income.    Section

7701(a)(15) defines “Armed Forces of the United States” to

include “all regular and reserve components of the uniformed

services which are subject to the jurisdiction of the Secretary

of Defense, the Secretary of the Army, the Secretary of the Navy,

or the Secretary of the Air Force, and each term also includes

the Coast Guard.”   Mr. Favero does not allege that he falls

within this definition.   Mr. Favero was a civilian employed as a

merchant seaman by U.S. businesses in 1995, 1996, and 1997.      Mr.

Favero was not a member of the Armed Forces of the United States

during the years in issue; thus he does not qualify for the

section 112 combat zone exclusion.     See Land v. Commissioner, 61

T.C. 675, 679 (1974).
                                     - 6 -

     Likewise, Mr. Favero does not qualify for the foreign earned

income exclusion.   Section 911(a) provides that a qualified

individual may exclude from gross income a certain amount of his

foreign earned income.   Sec. 911(b)(2)(A).       A qualified

individual is an individual whose tax home is in a foreign

country and who is either:     (1) A citizen of the United States

who establishes to the satisfaction of the Secretary that he has

been a bona fide resident of a foreign country or countries for

an uninterrupted period which includes an entire taxable year; or

(2) a citizen or resident of the United States who, during any

period of 12 consecutive months, is present in a foreign country

or countries during at least 330 full days in such period.        Sec.

911(d)(1).   An individual’s tax home for purposes of applying

section 911 is the same as an individual’s tax home for purposes

of section 162(a)(2), relating to traveling expenses while away

from home.   Sec. 911(d)(3).    An individual does not have a tax

home in a foreign country for any period for which his abode is

within the United States.      Id.     Petitioners have not provided any

evidence suggesting that Mr. Favero is a qualified individual or

that his wages during the years in issue constitute foreign

earned income.   Petitioners, therefore, do not qualify for the

section 911(a) foreign earned income exclusion.

     With respect to the Schedule C deduction petitioners claimed

on their 1995 return for Mrs. Favero’s “cottage industries”,
                               - 7 -

petitioners have failed to provide any evidence establishing that

Mrs. Favero’s claimed expenses were incurred for business

purposes.   Section 162(a) allows a deduction for all the ordinary

and necessary expenses paid or incurred during the taxable year

in carrying on a trade or business.    Section 262(a), however,

provides that no deduction is allowed for personal, living, or

family expenses.   Taxpayers are required to maintain records

sufficient to substantiate their claimed deductions.    Sec. 6001;

sec. 1.6001-1(a), Income Tax Regs.     Mrs. Favero’s testimony was

vague, and the copies of checks and receipts submitted as

evidence of her business expenses provide no basis to determine

the nature of the expenditures.   Petitioners, therefore, are not

entitled to the Schedule C deductions disallowed by respondent.

     Petitioners likewise have failed to establish they are

entitled to Schedule E expenses beyond those allowed by

respondent.   Although section 212 allows a deduction for ordinary

and necessary expenses paid or incurred during the taxable year

for the management, conservation, or maintenance of property held

for the production of income, nothing in the record establishes

that the expenses disallowed by respondent were incurred.    At

trial, Mrs. Favero indicated that some of the copies of checks

and receipts she submitted into evidence related to the

automobile expenses claimed on petitioners’ Schedule E.    As with

the Schedule C expenses, the copies of checks and receipts
                                - 8 -

provide no basis to determine the nature of the expenditures.

The records fall far short of meeting the strict substantiation

requirements of section 274(d) which apply to deductions relating

to the use of passenger automobiles.    Secs. 274(d)(4),

280F(d)(4)(A)(i); 1.274-5T(c)(1) and (2), Temporary Income Tax

Regs., 50 Fed. Reg. 46016, 46017 (Nov. 6, 1985).    Petitioners

failed to address any of the other Schedule E expenses disallowed

by respondent.   Consequently, we uphold respondent’s

determinations regarding petitioners’ Schedule E expenses in 1995

and 1996.

     At trial Mr. Favero stated that petitioners would like to

file their 1997 Federal income tax returns jointly.     Petitioners

filed separate 1997 returns.    Mr. Favero was issued a notice of

deficiency for his 1997 tax year, and Mr. Favero filed a petition

with the Court challenging respondent’s determinations with

respect to his 1997 tax year.   Section 6013(b)(2)(B) provides

that a joint return may not be filed after a separate return has

been filed and “after there has been mailed to either spouse,

with respect to such taxable year, a notice of deficiency under

section 6212, if the spouse, as to such notice, files a petition

with the Tax Court within the time prescribed in section 6213”.

Petitioners, therefore, may not file a joint return for their

1997 tax year.
                                  - 9 -

     Respondent determined that petitioners are liable for

accuracy-related penalties under section 6662(a) for each of the

years at issue.     Section 6662(a) imposes a penalty of 20 percent

of the portion of an underpayment attributable to negligence or

disregard of rules or regulations.        Sec. 6662(b)(1).

“Negligence” is defined as any failure to make a reasonable

attempt to comply with the provisions of the Internal Revenue

Code, and “disregard” is defined as any careless, reckless, or

intentional disregard.     Sec. 6662(c).     Negligence also includes

any failure by the taxpayer to keep adequate books and records or

to substantiate items properly.     Sec. 1.6662-3(b), Income Tax

Regs.

     The accuracy-related penalty does not apply if petitioners

had reasonable cause for the underpayment and acted in good faith

with respect to the underpayment.     Sec. 6664(c)(1).       Whether a

taxpayer acted with reasonable cause and in good faith is

determined on a case-by-case basis, taking into account all

pertinent facts and circumstances.        Sec. 1.6664-4(b)(1), Income

Tax Regs.      The most important factor generally is the extent of

the taxpayer’s effort to assess his proper tax liability.          Id.

An honest misunderstanding of fact or law that is reasonable in

light of all the facts and circumstances may indicate reasonable

cause.   Id.
                              - 10 -

     Petitioners did not address the accuracy-related penalties

at trial.   Petitioners claimed double deductions for the same

expenses, moving expenses when they never moved, a capital loss

when no such loss occurred, Schedule C and Schedule E deductions

for which they kept no decipherable records, and foreign earned

income exclusions for which they did not qualify.     Nothing in the

record establishes that petitioners had reasonable cause to claim

these deductions and exclusions, and we are not persuaded

petitioners acted in good faith.   Petitioners therefore are

liable for the accuracy-related penalties as determined by

respondent.

     To reflect the foregoing,

                                         Decision will be entered

                                    for respondent.
