                         T.C. Memo. 2001-39



                       UNITED STATES TAX COURT



          GLENN H. AND DIANE J. FLOOD, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 12279-98.                  Filed February 21, 2001.



     Cheryl R. Frank and Gerald W. Kelly, Jr., for petitioners.

     David Delduco, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION

     GERBER, Judge:    Respondent determined deficiencies and

accuracy-related penalties in petitioners’ Federal income taxes

as follows:

                                            Penalty
          Year        Deficiency          Sec. 6662(a)
          1991          $9,459               $1,892
          1992           9,212                1,842
          1993          23,323                4,665
                               - 2 -

      The issues for our consideration are:   (1) Whether

petitioners’ 1991, 1992, and 1993 income was underreported in the

amounts of $28,195, $22,695, and $74,013, respectively; (2)

whether petitioners are entitled to a 1992 bad-debt deduction

under section 166;1 (3) whether petitioners are entitled to a

1992 casualty loss deduction under section 165; (4) whether

petitioners’ 1992 gain from the sale of Glenwood Wrecker Service

was understated in the amount of $10,635; and (5) whether

petitioners are liable for the accuracy-related penalty under

section 6662(a) for the 1991, 1992, and 1993 tax years.

                         FINDINGS OF FACT2

      When their petition was filed, petitioners Glenn H. and

Diane J. Flood resided in Chatsworth, Georgia.    Glenn H. Flood

(petitioner) owned two businesses during the years in question,

Flood’s Auto Parts (FAP) and Glenwood Wrecker Service (Glenwood).

FAP

      During the tax years in issue petitioner owned and operated

FAP, a sole proprietorship located in Chatsworth, Georgia.    FAP

consisted of the wholesale and retail sale of auto parts, a

wrecker service, and the sale of junk cars to a scrap metal

      1
       Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the taxable periods under
consideration, and all Rule references are to the Tax Court Rules
of Practice and Procedure.

      2
       The parties’ stipulation of facts and exhibits is
incorporated herein by this reference.
                                 - 3 -

dealer.    Petitioner recorded most of the gross receipts for FAP

by creating invoices; however, he did not create an invoice for

every sale.    Petitioner had no other means to determine the

amount of unrecorded receipts.    Petitioner did not deposit all

proceeds from sales into his business or personal bank accounts

and also accumulated cash at his residence.    Petitioner reported

income for FAP on Schedule C, Profit or Loss From Business.      For

the years 1991, 1992, and 1993 FAP was petitioner’s primary

source of income.

Glenwood

     On May 27, 1988, petitioner purchased Glenwood from Glenn

Cantrell for $18,643 and initially operated the business as a

sole proprietorship.    An employee managed Glenwood until the

employee’s death that same year.    Soon after the employee’s

death, petitioner agreed to form a partnership with Sam

Hammontree (Hammontree), who subsequently became petitioner’s

brother-in-law.    Hammontree planned to draw cash from his

retirement fund to pay for a one-half partnership interest in

Glenwood, but he was unable to obtain the funds.    Instead,

petitioner and Hammontree orally agreed that Hammontree would

manage and receive a salary from Glenwood and pay petitioner from

Hammontree’s half of the business profits.
                                 - 4 -

     Petitioner and Hammontree filed a partnership tax return for

Glenwood for the calendar year 1988.      For the 1988 tax year,

Glenwood reported ordinary losses of $517 and claimed $5,000 in

section 179 expenses.    Glenwood’s Schedule K for 1988 reflected

that petitioner and Hammontree each owned 50 percent of the

partnership.    Petitioners reported flowthrough activity from

Glenwood for tax years 1988 through 1992 on their Forms 1040,

U.S. Individual Income Tax Return.

     Effective February 28, 1989, Glenwood became incorporated as

Glenwood Wrecker Service, Inc., and the Glenwood partnership was

terminated.    The partnership assets and liabilities were

exchanged for all of the issued stock in Glenwood.

Additionally, a short-year partnership tax return was filed for

the period ending February 28, 1989.      The partnership reported

ordinary income of $788 for the short tax year ending February

28, 1989.   Petitioner’s ending basis in Glenwood partnership and

his beginning basis in Glenwood corporation was $13,914.

     On April 25, 1989, petitioner and Hammontree personally

guaranteed a bank loan to Glenwood in the amount of $43,080.       The

loan was secured by Glenwood’s assets, which consisted of six tow

trucks and one office trailer.    Petitioner and Hammontree agreed

that $29,788.59 should be removed from the corporation by

Hammontree and paid to petitioner in payment for Hammontree’s

one-half interest in the business.       The following day, April 26,

1989, petitioner received a $29,788.59 corporate check, signed by
                               - 5 -

Hammontree.   Petitioner used the $29,788.59 to pay off

outstanding debts of FAP.

     For the short tax year beginning March 1, 1989, and ending

December 31, 1989, Glenwood elected S corporation status.

Glenwood filed Form 1120S, and reported ordinary income of $8,920

and claimed $8,900 in section 179 expenses.     The Glenwood Form

1120S reflected that petitioner and Hammontree were 50-percent

shareholders for the short tax year ending December 31, 1989.

     During the examination of petitioners, respondent determined

that the $29,788.59 received by petitioner was a distribution

from Glenwood reducing petitioner’s basis in Glenwood.

     In July 1992, petitioner sold his one-half interest in

Glenwood to Hammontree for $42,930.     Petitioner received a

cashier’s check for $40,000 from Hammontree and a separate check

directly from Glenwood for $2,930.     Petitioners reported a

capital gain from the sale of Glenwood stock in the amount of

$19,344 on their 1992 Form 1040, U.S. Individual Income Tax

Return.   Respondent determined that petitioners understated their

capital gain on the sale of Glenwood by $10,635.

The Murray Avenue Auction

     In 1986, petitioner began working for the Murray Avenue

Auction (the auction).   The auction was wholly owned by

petitioner’s father, John Flood, until 1987.     On January 1, 1987,

petitioner’s stepmother, Willene Flood, acquired an ownership

interest in the auction and applied for a certificate of
                                - 6 -

registration with the Georgia Department of Revenue.

     The auction’s primary activity was selling items such as

toys, tools, furniture, and collectibles that it acquired in

bulk.    Petitioner, a licensed auctioneer, worked at the auction

and as a buyer, traveled to different locations to acquire the

items subsequently sold at the auction.    Petitioner’s sister also

worked at the auction.

        Petitioner cosigned and made payments on several bank loans

which were used for the benefit of his father and the auction.

The total amount advanced to petitioner’s father was $107,036.

Petitioner did not have an ownership interest in the auction.    In

1992, a fire completely destroyed the auction, for which

petitioner’s father and stepmother claimed a casualty loss

deduction of $55,825 on their Form 1040 for the 1992 tax year.

Petitioners’ Income as Determined by Respondent for 1991

     For the tax year 1991, respondent, using the source and

application of funds method, determined that petitioners had

unreported income.    To compute unreported income using this

method, the funds petitioners used were identified through their

expenditures during the tax year 1991 and then compared with

petitioners’ total available funds from all sources during the

tax year 1991.    Where the expenditures exceeded known available

sources of funds, the difference was determined to be income.    As

part of the calculation, respondent excluded funds that were

accumulated during prior taxable years.
                                - 7 -

     To make his determination as to petitioners’ income for

1991, respondent used the following information:

     Source of funds:
          Adjusted gross income                         $19,283
          Loan balance 12/31/91                         100,000
          Bank account balances 1/1/91                    7,081
          Moneys advanced from daughter                   4,500
          Depreciation (noncash deduction)                4,620
          Self-employment tax AGI deduction               1,133
          Glenwood loan receivable                       31,301
          Cash on hand 1/1/91                             3,000
                                                      1
          Total sources available                       170,918

     Application of funds:
          Personal living expenses                     $23,780
          Loan balance 1/1/91                           99,013
          Funds to construct house for daughter         30,301
          Bank balance 12/31/91                            284
          Payment of father’s loan                      34,001
          Glenwood loan receivable 12/31/91               -0-
          Increase in inventory                          4,288
          Increase to capital/Glenwood                   4,379
          Building improvements                          6,067
          Cash on hand 12/31/91                          3,000

            Total application of funds                 205,113
            Total sources available                    170,918

            Understatement of income                    34,195
            Less specific adjustments/rental income     (6,000)

            Understatement of income                    28,195
        1
          Although the parties have stipulated $170,915, it
     appears the correct amount is $170,918.
                               - 8 -

Petitioners’ Income as Determined by Respondent for 1992

     For the tax year 1992, respondent, using the source and

application of funds method, determined that petitioners had

unreported income.   To make his determination, respondent used

the following information:

     Source of funds:
          Adjusted gross income                     $26,805
          Loan balance 12/31/92                      56,894
          Bank account balances 1/1/92                  284
          Moneys advanced from daughter               1,000
          Depreciation (noncash deduction)            4,329
          Basis in asset sold                        20,656
          Cash on hand 1/1/92                         3,000

          Total sources available                   112,968

     Application of funds:
          Personal living expenses                  $24,093
          Loan balance 1/1/92                       100,000
          Funds to construct house for daughter       4,697
          Bank balance 12/31/92                       1,667
          Increase in inventory                       5,000
          Increase to capital/Glenwood                6,136
          Cash on hand 12/31/92                       3,000

          Total application of funds                144,593
          Total sources available                   112,968

          Understatement of income                   31,625
          Additional proceeds from sale of
           Glenwood                                  (2,930)
          Sale of equipment                          (6,000)

          Understatement of income                   22,695

Petitioners’ Income as Determined by Respondent for 1993

     For the tax year 1993, respondent, using the source and

application of funds method, determined that petitioners had

unreported income.   To make his determination, respondent used
                               - 9 -

the following information:

     Source of funds:
          Adjusted gross income                       $15,154
          Loan balance 12/31/93                        52,210
          Bank account balances 1/1/93                  1,667
          Depreciation (noncash deduction)             20,276
          Amount payable on equipment 12/31/93         21,328
          Self-employment tax deduction                   848
          Cash on hand 1/1/93                           3,000

          Total sources available                     114,483

     Application of funds:
          Personal living expenses                    $21,980
          Loan balance 1/1/93                          56,894
          Bank balance 12/31/93                         3,250
          Increase in inventory                        67,868
          Equipment purchases                          35,504
          Amount payable on equipment 1/1/93             -0-
          Cash on hand 12/31/93                         3,000

          Total application of funds                  188,496
          Total sources available                     114,483

          Understatement of income                     74,013

                              OPINION

     We consider here whether petitioners underreported income

from the sale of a capital asset and from a business.     We also

consider whether petitioners are entitled to a bad debt and/or a

casualty loss deduction.   Finally, we must decide whether

petitioners are liable for accuracy-related penalties.

Was Petitioners’ 1991, 1992, and/or 1993 Business Income
Underreported?

     Respondent, using the source and application of funds

method, determined that petitioners’ income was underreported for

the tax years 1991, 1992, and 1993 in the amounts of $28,195,

$22,695, and $74,013, respectively.     Petitioners contend that
                              - 10 -

respondent used an understated amount of cash on hand in the

calculation of petitioners’ business income.   A larger amount of

cash on hand would reduce respondent’s income determination under

the source and application of funds method.

     Taxpayers are required to keep adequate records with which

the Commissioner may determine their correct tax liability.    See

sec. 6001; sec. 1.6001-1(a), (d), Income Tax Regs.   In the

absence of such adequate records, the Commissioner may

reconstruct income using a method that clearly reflects income.

See Cebollero v. Commissioner, 967 F.2d 986, 989 (4th Cir. 1992),

affg. T.C. Memo. 1990-618; Petzoldt v. Commissioner, 92 T.C. 661,

687 (1989).   The Commissioner may use indirect methods to

reconstruct income, so long as they are reasonable in the

circumstances.   See Holland v. United States, 348 U.S. 121, 126

(1954); Giddio v. Commissioner, 54 T.C. 1530, 1532-1533 (1970).

     Respondent reconstructed petitioners’ income using the

source and application of funds method.   Petitioners do not

question respondent’s use of the source and application of funds

method for reconstructing their income.   Petitioners argue,

however, that respondent’s determination of their income was

overstated because respondent used too small an amount of cash on

hand in the computation.   Petitioners do not question other

aspects of respondent’s calculations.   Accordingly, we must

consider whether respondent erred in the reconstruction of

petitioners’ income only with respect to the amount of cash
                              - 11 -

petitioners maintained at their residence.

      As part of the reconstruction of income using the source

and application of funds method, funds that were accumulated

before the first taxable year under examination must be excluded.

During the examination, petitioner told respondent’s agent that

petitioners kept approximately $3,000 in cash at their residence.

Relying on petitioner’s representation, respondent used $3,000 in

the reconstruction of petitioners’ income.

     Petitioners now contend that $3,000 does not represent the

correct amount of cash on hand and that petitioners actually had

as much as $30,000 in cash at their residence.   The only evidence

petitioners offered on this point was petitioner’s oral

testimony.   On direct examination petitioner was asked:   “Now

today, with your knowledge of the facts, is that [$3,000] number

accurate, or is it higher or lower?”   Petitioner responded:

          I just prefer to leave it the same. I don’t
          know. I couldn’t tell you the truth about
          that. I’d just rather just leave it the
          same, but I probably had--I had to have more
          money than what I told him. That’s the only
          thing I can say about it, but that’s been a
          long time ago. Let’s just leave it $3,000,
          and just let it ride like that. That’s what
          I would say. [Emphasis added.]
                              - 12 -

Accordingly, petitioners have failed to show that respondent

erred by using $3,000 as cash on hand.   Therefore, respondent’s

reconstruction of petitioner’s income is upheld in full.

Have Petitioners Shown That Advances to Petitioner’s Father Were
Loans and That They Became Worthless During 1992?

     We next consider whether petitioner is entitled to a section

166 bad-debt deduction for advances made to or on behalf of his

father.   Petitioners argue that they are entitled to ordinary

loss treatment because the advances were loans made in

furtherance of petitioner’s trade or business and that said loans

became worthless when the auction was destroyed by fire in 1992.

Respondent argues that the advances petitioner made were gifts

which did not have the requisite characteristics of a bona fide

debt for the purposes of section 166.3

     In order to maintain an ordinary loss deduction for a bad

debt, a taxpayer must demonstrate that the advances qualify for

section 166 treatment.   See White v. United States, 305 U.S. 281

(1938); United States v. Virgin, 230 F.2d 880 (5th Cir. 1956).     A

taxpayer’s entitlement to section 166 treatment depends upon a

showing that a bona fide debt existed and that the debt became

uncollectible during the year in which the deduction is claimed.

See sec. 166; Rule 142(a); Welch v. Helvering, 290 U.S. 111


     3
       Petitioners did not claim this loss on their returns.
Instead, the loss was claimed in an attempt to offset
respondent’s deficiency determination. Because of our holding,
this issue has no effect on the deficiency determined or the
accuracy-related penalties.
                                - 13 -

(1933).   A bona fide debt is one that arises from a debtor-

creditor relationship and is based upon a legally valid and

enforceable obligation to pay a fixed or determinable sum of

money.    See sec. 1.166-1(c), Income Tax Regs.

     We have held that our consideration of whether a taxpayer

created a debt with a true expectation of repayment and with the

intent to enforce the repayment of that debt requires an

examination of the facts and circumstances.     The following

factors have been used to aid in deciding whether an advance is

“debt” within the meaning of section 166:     (1) The existence of a

promissory note or written evidence of indebtedness; (2) whether

and in what amount interest is charged; (3) whether there is a

fixed repayment schedule; (4) whether there is security or

collateral for the debt; (5) whether the lender made a demand for

repayment; (6) whether the loan is reflected as a loan in the

parties’ books and records; (7) whether and in what amounts any

repayments have occurred; and (8) the solvency of the borrower at

the time the parties made the loan.      See, e.g., Mayhew v.

Commissioner, T.C. Memo. 1994-310.

     Considering these factors in light of the record, we

conclude that petitioners have not established the existence of a

bona fide debt to petitioner.    Petitioners did not offer evidence

of a promissory note or similar type of instrument of

indebtedness that would identify the advances as loans.     Although

petitioners reported $125 of interest income on their Form 1040
                              - 14 -

for the 1990 tax year, the source of that interest has not been

shown.   In addition, $125 of interest income is wholly

disproportionate to the $107,036 that petitioner alleges he lent

to his father.

     Although petitioner’s father owned assets other than the

auction, such as rental property and the land on which FAP’s

business was situated, petitioner did not require security to

guard against default.   Further, petitioner did not protect his

position to collect from his father’s assets in the event of

competing creditors.   Petitioner did not seek collection or

repayment from his father.   Petitioner’s testimony was that he

did not ask his father for repayment because “he is my father”.

     Petitioner contends that his father made two lump-sum

partial repayments and that those repayments are indicia of bona

fide debt.   However, there was no contemporary repayment

schedule, and the only evidence of repayment was a handwritten

schedule submitted for trial purposes.   The schedule submitted

for trial reflected that the first repayment of $19,505 was made

to the lending bank and the second repayment of $13,000 was made

to petitioners.

     We review transactions between family members with

heightened scrutiny.   See Caligiuri v. Commissioner, 549 F.2d

1155, 1157 (8th Cir. 1977), affg. T.C. Memo. 1975-319; Perry v.

Commissioner, 92 T.C. 470, 481 (1989), affd. without published

opinion 912 F.2d 1466 (5th Cir. 1990).   Loans between family
                               - 15 -

members have been considered gifts in the absence of sufficient

evidence of a true expectation of repayment and intent to enforce

collection of the debt.    See Perry v. Commissioner, supra at 481;

Estate of Reynolds v. Commissioner, 55 T.C. 172, 201 (1970);

Estate of Van Anda v. Commissioner, 12 T.C. 1158 (1949), affd.

per curiam 192 F.2d 391 (2d Cir. 1951).    Even if petitioner’s

father made the two payments reflected in the trial exhibit, that

evidence is insufficient, by itself, to show the existence of

bona fide debt.

        Had petitioners shown that a bona fide debt existed, they

would not have been entitled to a deduction for the tax year 1992

because petitioners did not show worthlessness in that year.      See

sec. 166(a)(1).    In determining the worthlessness of a debt, all

available evidence including the value of any security and the

financial condition of the debtor must be considered.    See sec.

1.166-2(a), Income Tax Regs.    A taxpayer must provide evidence of

the worthlessness of the debt.    See sec. 1.166-2(b), Income Tax

Regs.    A debt becomes worthless in the tax year in which a

creditor, using sound business judgment, abandons all reasonable

hope of recovery on the basis of the available information

regarding the surrounding circumstances of the debt.    See Crown
                              - 16 -

v. Commissioner, 77 T.C. 582, 598 (1981); Andrew v. Commissioner,

54 T.C. 239, 248 (1970); sec. 1.166-2(a), Income Tax Regs.

     Petitioners argue that the loans became worthless in 1992

when the auction was destroyed by fire.   Petitioner argues that

the auction was his father’s sole source of income, the

destruction of which resulted in an inability to repay the

advances.   It is not entirely clear from the record who owned the

auction at the time of the fire.   It appears from the record,

however, that the auction was owned entirely by petitioner’s

father and/or stepmother.

     Although legal action by petitioner against his father is

not required to show his father’s inability to repay the

advances, in the absence of such action, petitioner must still

show that legal action would not have resulted in the

satisfaction of the debt.   See sec. 1.166-2(b), Income Tax Regs.

Petitioner’s father owns the land upon which FAP is located.

Schedule D, Capital Gains and Losses, of John and Willene Flood’s

1992 income tax return shows the sale of a building for a gain of

$30,000, 2 weeks before the auction fire.   Additionally, Schedule

E, Supplemental Income and Loss, of the 1992 income tax return

shows that the couple owned rental property at the time of the

fire.

     Accordingly, petitioners have failed to show that the

advances were loans.   Even if petitioners had shown that the

advances were debt within the meaning of section 166, petitioners
                               - 17 -

have not shown that they became worthless during 1992.

Are Petitioners Entitled to a Casualty Loss Deduction?

     We next consider whether petitioners are entitled to a

casualty loss deduction under section 165 for losses stemming

from the destruction of the auction.    Petitioners advanced their

casualty loss argument for the first time in their brief as an

entirely new and separate issue.    After considering that this

issue was not tried by consent of the parties and that surprise

and prejudice to respondent would result, we hold that the issue

was not timely raised.    See Estate of Horvath v. Commissioner, 59

T.C. 551, 555 (1973).    Petitioners’ casualty loss argument

appears to be an afterthought.    Petitioners have not shown that

they had an ownership interest in the auction.    Additionally,

petitioners’ argument conflicts factually with petitioner’s

father’s and stepmother’s claim of a $55,825 casualty loss for

the same property.

Petitioner’s Basis in Glenwood

     We next consider whether petitioners have shown that they

correctly reported capital gain from the 1992 sale of Glenwood.

Section 1001(a) provides that gain from the sale or disposition

of property shall be the excess of the amount realized over the

adjusted basis.   Section 1001(b) provides that the amount

realized is the sum of money received plus the fair market value

of any property received.    Section 1001(c) requires that the

amount of gain on the sale or exchange of property be recognized
                               - 18 -

unless there are specific provisions for nonrecognition.

     Respondent determined that petitioners understated their

capital gain from the sale of Glenwood by $10,635.     The increased

capital gain results, in part, from respondent’s characterizing a

$29,788.59 check from Glenwood to petitioner as a distribution

which reduced petitioner’s basis in Glenwood to zero.     The issue

before us is purely factual.

     Petitioners argue that the $29,788.59 was a distribution to

Hammontree from Glenwood and, in turn, a payment to petitioner in

exchange for Hammontree’s acquisition of a 50-percent interest in

Glenwood from petitioner.   We agree with petitioner.    In 1988

petitioner and Hammontree agreed that Hammontree would use funds

from a retirement account to become a 50-percent partner in

Glenwood.   However, Hammontree was unable to draw from the

account.    Thereafter, it was understood that Hammontree would run

the business and take a salary and that petitioner’s one-half

interest in Glenwood would be paid for from Hammontree’s profit

and/or salary from the partnership.     Glenwood’s Federal income

tax returns for 1988 and short year 1989 reflect a 50-50

partnership.   Early in 1989, however, Glenwood was incorporated,

the partnership was discontinued, petitioner and Hammontree

became equal shareholders, and petitioner had not been paid for
                              - 19 -

Hammontree’s 50-percent ownership in Glenwood.   Around that time,

petitioner’s basis in his Glenwood shares was $13,914.

     On April 25, 1989, petitioner and Hammontree personally

guaranteed a loan in Glenwood’s name for $43,080 which was

secured by Glenwood’s operating assets.   On April 26, 1989, in

accord with the original agreement of petitioner and Hammontree,

petitioner received a $29,788.59 payment from Glenwood.    It was

their understanding that the $29,788.59 paid to petitioner was

Hammontree’s payment for one-half of the shares in Glenwood.

     In a July 1992 purchase of petitioner’s remaining 50-percent

interest in Glenwood, Hammontree used corporate funds to finance

a portion of the transaction, showing a pattern in the way

petitioner and Hammontree orchestrated their affairs.

Considering the record as a whole, the $29,788.59 payment was a

payment from Hammontree for petitioner’s interest in the

business.4   Accordingly, we hold that the $29,788.59 payment was

not a corporate distribution to petitioner and that it was from

Hammontree.5




     4
       We are not required here to consider what effect
Hammontree’s withdrawal of $29,788.59 from Glenwood had on
Hammontree’s tax situation.
     5
       The extent to which our holding has any effect on
petitioner’s basis in Glenwood’s stock should be determined by
the parties under Rule 155.
                               - 20 -

Section 6662(a)--Accuracy-Related Penalty

       Finally, we consider whether petitioners are liable for an

accuracy-related penalty under section 6662(a).     Respondent

determined that a 20-percent accuracy-related penalty, based on

negligence, applied to the entire income tax deficiency for the

1991, 1992, and 1993 tax years.

       An accuracy-related penalty is imposed by section 6662(a) in

an amount equal to 20 percent of the amount of the underpayment

that is attributable to negligence.     See sec. 6662(b)(1).

“Negligence” is the failure to make a reasonable attempt to

comply with the provisions of the Internal Revenue Code.       Sec.

6662(c).

       A taxpayer is negligent where he fails to exercise due care

or fails to do what a reasonable and ordinarily prudent person

would do under similar circumstances.     See Neely v. Commissioner,

85 T.C. 934, 947-948 (1985).

       Petitioners contend that they were not negligent and should

not be subject to the accuracy-related penalty because they

provided sufficient records containing FAP’s major tranactions to

their return preparer, leaving out only the minor sales.

Respondent contends that petitioners were negligent when they

failed to record and report all of FAP’s sales transactions.

       Petitioner did not maintain adequate books and records for

FAP.    Petitioner testified that sales, from $1 to $10, were

regularly omitted from recordkeeping and that FAP employees may
                               - 21 -

also have forgotten to record other sales of unknown amounts.

Petitioner’s testimony reveals that he was aware that invoices

may not have been prepared for a number of larger items sold by

FAP.    Petitioner used the understated amount reflected by the

invoices to prepare summary sheets which he then provided to the

return preparer.    Petitioner failed to inform the return preparer

that certain sales were omitted.      In addition, petitioner did not

always deposit the proceeds from FAP’s sales into a bank

account; therefore, there was no record of some portion of the

sales.

       Petitioners also contend that these unrecorded and

unreported sales were of minor consequence.      However,

respondent’s reconstruction of petitioners’ income reflects

relatively sizable amounts of omitted income.        As to the

remaining items making up the deficiency, apart from the capital

gain item, petitioners did not make any argument as to why

respondent’s determination was in error or that their return

position was reasonable.    Therefore, we find petitioners liable

for the accuracy-related penalties on the resulting income tax

deficiencies.

       To reflect the foregoing,

                                        Decision will be entered

                                   under Rule 155.
