                             149 T.C. No. 19



                    UNITED STATES TAX COURT



JAMES M. GALLOWAY AND SARAH M. GALLOWAY, Petitioners v.
    COMMISSIONER OF INTERNAL REVENUE, Respondent



 Docket No. 8170-14.                           Filed October 10, 2017.



        On their 2011 Federal income tax return, Ps claimed a $7,500
 credit under I.R.C. sec. 25A for expenses related to their children's
 postsecondary education. Petitioners failed to carry from Form 8863
 to Form 1040 the $4,500 nonrefundable portion of the credit,
 claiming on Form 1040 only the $3,000 refundable portion, which
 reduced the tax shown on the return from $6,984 to $3,984. In
 processing Ps' return, R adjusted Ps' tax liability to take into account
 the $4,500 nonrefundable portion of the credit and refunded to Ps
 $4,500 more than the amount they had requested. After examination
 R disallowed Ps' claimed $7,500 credit in full, and Ps now concede
 that they are not entitled to any credit under I.R.C. sec. 25A for 2011.

        Held: When the Commissioner makes a rebate to a taxpayer
 for a year in excess of the amount of tax shown on the taxpayer's
 return for the year, that excess increases the taxpayer's "deficiency",
 within the meaning of I.R.C. sec. 6211(a); thus Ps' deficiency for
 2011 is $7,500 ($6,984 & ($3,984 & $4,500)).
                                         -2-

            Held, further, R's imposition of a $1,500 accuracy-related
      penalty under I.R.C. sec. 6662(a) is sustained.



      T. Keith Fogg, Andrew R. Roberson, and Denise M. Mudigere, for

petitioners.

      Lori A. Amadei, for respondent.



      HALPERN, Judge: Respondent determined a deficiency of $7,500 in

petitioners' 2011 Federal income tax and an accuracy-related penalty for that year

of $1,500. The deficiency arises from respondent's disallowance of a $7,500

American Opportunity Credit (AOC) petitioners claimed under section 25A(i)(1)1

on their 2011 Federal income tax return. Petitioners reported a total credit of

$7,500 on Form 8863, Education Credits (American Opportunity and Lifetime

Learning Credits), including a refundable portion of $3,000. They failed,

however, to carry the $4,500 nonrefundable portion of the credit to their Form

1040, U.S. Individual Income Tax Return. Respondent reduced petitioners' tax

liability by $4,500 in processing their return to take into account the

nonrefundable portion of the credit and refunded to petitioners $4,500 more than

      1
       All section references are to the Internal Revenue Code in effect for 2011
unless otherwise indicated.
                                         -3-

they had requested. The parties agree that the $4,500 additional refund was a

"rebate", within the meaning of sections 6211(b)(2) and 6664(a) (flush language).

Petitioners concede that they are not entitled to any AOC for 2011. The parties

thus also agree that the tax imposed on petitioners for 2011 by subtitle A is

$6,984, the amount shown as "total tax" on line 61 of petitioners' Form 1040. The

issues remaining for decision are: (1) whether respondent correctly computed

petitioners' 2011 deficiency (in particular, whether the excess of the rebate

respondent made over the tax shown on petitioners' return (net of the refundable

credit) increases their deficiency from $6,984 to $7,500) and (2) whether

petitioners are liable for the accuracy-related penalty that respondent determined.

                               FINDINGS OF FACT

Petitioners' Reporting of Education Credits for 2007

      On a Form 8863, Education Credits (Hope and Lifetime Learning Credits),

included with their 2007 Form 1040, petitioners claimed a Hope Credit for

qualified expenses of two of their dependent children, G.G. and J.G. The total

education credits reported on line 17 of petitioners' 2007 Form 8863 also appear

on line 49 of their Form 1040 for that year, reducing their total tax to zero.
                                          -4-

Petitioners' 2011 Reporting

        Petitioners' Form 1040 for 2011 also included a Form 8863, which reported

qualified expenses for each of J.G., G.G., and E.G. (another dependent child of

petitioners). G.G. and J.G. each completed his or her undergraduate degree in the

spring term of 2011. Petitioners' 2011 Form 8863 reports a tentative AOC of

$2,500 per child, or $7,500, and a refundable AOC of $3,000 ($7,500 × 40%).

The $3,000 refundable AOC also appears on line 66 of petitioners' 2011 Form

1040.

        Part IV of petitioners' 2011 Form 8863 is incomplete. It reports on line 15

the $4,500 difference between the total AOC claimed and the $3,000 refundable

portion of the credit, but that difference is not carried to either line 23 of the Form

8863 (nonrefundable education credits) or line 49 of petitioners' Form 1040.

        Petitioners' 2011 Form 8863 provided no facts related to the claimed credit

other than the qualified expenses attributable to each child.

        Petitioners, who resided in California when they filed their petition,

reported $8,287 of Federal income tax withheld from their wages for 2011. Their

Form 1040 for that year did not include a Form 8275, Disclosure Statement.
                                         -5-

Petitioners' 2011 Refund

      Petitioners claimed a refund on their 2011 return of $4,303, but respondent

alleges--and petitioners concede--that he actually issued them a refund for that

year of $8,803. The record provides no indication that they returned any portion

of their 2011 refund.

Mr. Galloway's Trial Testimony

      Mr. Galloway conceded at trial that petitioners were not entitled to any

AOC for tuition or expenses paid on behalf of E.G. in 2011, but he did not explain

the basis for that concession. On brief, petitioners concede that they are not

entitled to any AOC for 2011. When we asked Mr. Galloway at trial whether he

had any testimony to show reasonable cause for petitioners' belief that they were

entitled to the claimed AOC, he responded: "When we prepared the * * * taxes,

we used a guide--I believe it was Lassiter's Guide--in doing so. It is a confusing

section with two options to take for educational credits. And we did the best we

could to follow the guidelines in there and the instructions on the forms."
                                         -6-

                                      OPINION

I.    The Amount of Petitioners' Deficiency

      A.     Applicable Law

      Section 6211(a) defines "deficiency" to mean "the amount by which the tax

imposed by subtitle A * * * exceeds the excess of -- (1) the sum of (A) the amount

shown as the tax by the taxpayer upon his return * * * plus (B) the amounts

previously assessed (or collected without assessment) as a deficiency, over -- (2)

the amount of rebates, as defined by subsection (b)(2), made." Section 6211(b)(2)

defines "rebate" as "so much of an abatement, credit, refund, or other repayment,

as was made on the ground that the tax imposed by subtitle A * * * was less than

the excess of the amount specified in subsection (a)(1) over the rebates previously

made."

      Before the enactment of the Technical and Miscellaneous Revenue Act of

1988 (TAMRA), Pub. L. No. 100-647, 102 Stat. 3342, taxpayers could not contest

the Commissioner's disallowance of refundable credits in deficiency proceedings

before this Court if they had no tax liability even after disallowance of the credits

and thus had no deficiencies. See H.R. Rept. No. 100-795, at 366 (1988); S. Rept.

No. 100-445, at 387 (1988), 1988 U.S.C.C.A.N. 4515, 4897. Congress amended

section 6211(b)(4) as part of TAMRA to remedy that situation. TAMRA sec.
                                         -7-

1015(r)(2), 102 Stat. at 3572; see also Wilson v. Commissioner, T.C. Memo.

2001-139, 2001 WL 667843, at *2 ("The legislative history of section 6211(b)(4)

reveals that the provision was enacted to expand the definition of a deficiency to

permit taxpayers to contest the disallowance of the earned income credit in the Tax

Court."); H.R. Rept. No. 100-795, supra at 366; S. Rept. No. 100-445, supra at

387, 1988 U.S.C.C.A.N. at 4897. Under section 6211(b)(4), any excess of

refundable credits allowable over the tax imposed by subtitle A, and any excess of

reported refundable credits over the tax reported on a taxpayer's return, "shall be

taken into account as negative amounts of tax" for purposes of section 6211(a).

Thus, the disallowance of refundable credits claimed by a taxpayer with no tax

liability even after that disallowance would result in a deficiency because the tax

imposed would be larger (that is, less negative) than the tax shown on the

taxpayer's return.

      The refundable portion of the AOC is among the refundable credits to which

section 6211(b)(4), by its terms, applies. Section 25A(b)(1) allows a

"Hope Scholarship Credit" of up to $1,500 per year of an eligible student's

qualified tuition and related expenses for postsecondary education. Section

25A(i)(1) increased the limit to $2,500 per year for a taxable year beginning in

2009, 2010, 2011, or 2012 (and referred to the increased Hope Scholarship Credit
                                          -8-

as the "American Opportunity Tax Credit"). A credit under section 25A can be

claimed for an eligible student for no more than four taxable years. Sec.

25A(b)(2)(A), (i)(2). Although the AOC is generally limited to the taxpayer's tax

liability, sec. 26(a)(1), 40% of the credit is refundable to the taxpayer to the extent

it exceeds the taxpayer's tax liability, sec. 25A(i)(6). The credits to which section

6211(b)(4) applies include "the credits allowable under section[] * * * 25A by

reason of subsection (i)(6) thereof".

      B.     The Parties' Positions

      Respondent's determination of a $7,500 deficiency reflects the following

calculation: $6,984 tax imposed ! ($3,984 tax shown on return ! $4,500 rebate).2

The $3,984 tax shown on petitioners' return--an amount with which petitioners

agree--equals the $6,984 total tax shown on line 61 of their 2011 Form 1040

reduced by the $3,000 refundable credit reported on line 66 of that form. Cf. sec.

6211(b)(1) (providing that the tax imposed and the tax shown on a taxpayer's

return are determined without regard to specified credits that do not include the

credit allowed by section 25A); Rand v. Commissioner, 141 T.C. 376, 387-388


      2
        The parties agree that respondent did not previously assess any deficiencies
against petitioners for 2011 and did not collect as deficiencies any amounts from
petitioners for that year. Thus, petitioners' 2011 deficiency turns on three
amounts: tax imposed, tax shown on the return, and rebates.
                                         -9-

(2013) (reasoning that credits not specified in section 6211(b)(1) reduce the tax

shown on the taxpayer's return for the purpose of computing a deficiency).

Respondent's position rests on the premise that the excess of the tax shown on a

taxpayer's return over any rebates made can be a negative amount that increases

the taxpayer's deficiency when the amount of the rebate exceeds the amount of tax

shown. (Because the excess of the tax shown on the return over rebates is

subtracted from the tax imposed to arrive at the taxpayer's deficiency, if that

excess is a negative number, subtracting it from the tax imposed will increase the

taxpayer's deficiency.)

      In normal parlance, one might say that if amount B is larger than amount A,

then A does not exceed B by any amount--that is, the excess of A over B is zero.

Nonetheless, it "is both linguistically and mathematically possible" for the excess

of a smaller number over a larger one to be a negative amount. Indianapolis Life

Ins. Co. v. United States, 115 F.3d 430, 435 (7th Cir. 1997). Moreover, as

respondent observes, in applying the statutory formula provided in section 6211(a)

for determining a deficiency, we have implicitly accepted the premise that the

excess of the tax shown on a return over rebates can be negative. See Voigt v.

Commissioner, T.C. Memo. 2004-62; Wilson v. Commissioner, 2001 WL 667843;

Blore v. Commissioner, T.C. Memo. 2000-326. Each of those cases involved
                                         -10-

similar facts. Wilson, for example, involved a taxpayer who had a tax liability of

zero and claimed an overpayment on the basis of an earned income tax credit of

$335. The Commissioner disallowed the claimed credit. We concluded that the

disallowance of the credit resulted in a deficiency. Wilson v. Commissioner, 2001

WL 667843, at *3 ("[R]espondent's determination that petitioner's correct tax

liability is zero and that petitioner is not entitled to an earned income credit

constitutes the determination of a deficiency within the meaning of section

6211."). Under section 6211(b)(4), the claimed credit resulted in a negative

amount of tax shown on the taxpayer's return, specifically !$335. The tax

imposed was zero. The Commissioner made no rebates to the taxpayer for the

year in issue. Thus, the tax imposed ($0) exceeded the excess of the tax shown on

the return over rebates (!$335 ! $0 ' !$335). The amount of the rebate ($0) was

larger than the negative amount of tax shown on the return. Thus, our

determination of a deficiency necessarily rested on the premise that the excess of

tax shown over rebates can be a negative number. Were that not so, the taxpayer

in Wilson would have had no deficiency and would have been unable to contest in

this Court the Commissioner's disallowance of his claimed earned income tax

credit, contrary to the purpose of section 6211(b)(4).
                                         -11-

      In the face of our prior caselaw and the need to carry out the purpose of

section 6211(b)(4), it is not surprising that petitioners do not challenge the general

proposition that, in computing a taxpayer's deficiency, the excess of the tax shown

on a return over rebates can be a negative number. They allege, however, that that

proposition holds only "where no rebates exist." They argue that "it does not

follow" from the general proposition "that an 'excess' of tax shown over the rebate

exists when Respondent has made a 'rebate' exceeding the positive tax shown on

the return." And why might it be that the excess of tax shown over rebates can be

negative in some cases and not others? Petitioners profess concern about possible

"manipulation" by the Commissioner: "The logical extension of Respondent's

argument", they warn, "would permit Respondent to manipulate the[] calculation

by unilaterally issuing rebates whenever it benefitted Respondent." On the basis

of that concern, petitioners argue that their deficiency is limited to the tax imposed

of $6,984.

      C.     Analysis

      For several reasons, we reject petitioners' proposed limitation on the amount

of their deficiency and accept respondent's calculation. To begin with, the text of

section 6211(a) provides no basis for giving a different interpretation to the phrase

"the excess of * * * the amount shown as the tax by the taxpayer upon his return
                                        -12-

* * * over * * * the amount of rebates * * * made" depending on whether any

rebates have, in fact, been made. Second, we are hard pressed to imagine cases in

which the Commissioner would find it to his advantage to pay a taxpayer an

amount to which the taxpayer was not entitled simply to give him grounds to

recover the overpayment as part of a deficiency. Third, even were such prospects

to arise, the Commissioner could not willy-nilly treat payments to taxpayers as

rebates. An amount paid to a taxpayer qualifies as a "rebate" only to the extent

that it was made on the ground that the tax imposed was less than the excess of the

tax shown on a taxpayer's return (plus prior assessments) over any prior rebates.

See sec. 6211(b)(2).3

      3
        Although petitioners have not given us an example of a case in which the
Commissioner would be advantaged by making a strategic "rebate" to manipulate
the amount of a taxpayer's deficiency, petitioners may have in mind the possibility
of payments made to a taxpayer to avoid the limitation on "underpayment" we
established in Rand v. Commissioner, 141 T.C. 376 (2013). As explained infra
part II.A, the definition of "underpayment" in sec. 6664(a) is essentially the same
as the definition of "deficiency" in sec. 6211(a)--that is, the amount by which the
tax imposed exceeds the excess of the tax shown on the return over any rebates.
Because no rule analogous to that of sec. 6211(b)(4) then applied for the purpose
of determining an underpayment, we concluded in Rand v. Commissioner, 141
T.C. at 390-391, that, for that purpose, refundable credits could not reduce the tax
shown on a return below zero. But see Consolidated Appropriations Act, 2016,
Pub. L. No. 114-113, div. Q, Protecting Americans from Tax Hikes Act of 2015
(PATH), sec. 209(a), 129 Stat. at 3084 (amending sec. 6664(a) to provide that a
rule similar to that of sec. 6211(b)(4) applies for purposes of sec. 6664(a)).

                                                                       (continued...)
                                         -13-

      Petitioners concede that they received $7,500 from the Government to

which they were not entitled. They agree that they are liable for tax of $6,984 for

2011. They had $8,287 withheld from wages during that year. Thus, they were

entitled to a refund of $1,303 ($8,287 ! $6,984). Instead, they received a refund

of $8,803--$7,500 more than they deserved. Petitioners offer no logical reason

why their deficiency should be limited to $6,984 and the Government forced to

file an erroneous refund suit under section 7405, if still timely, to collect the

additional $516. The Commissioner would have no grounds for making a rebate

to a taxpayer in excess of the tax shown on the taxpayer's return unless the


      3
         (...continued)
        Suppose, for example, that petitioners had carried from Form 8863 to their
Form 1040 the nonrefundable portion of their claimed AOC. In that case, the tax
shown on their return, for purposes of computing a deficiency, would have been
!$516 ($6,984 ! $7,500). Respondent's disallowance of the claimed AOC would
have resulted in a deficiency of $7,500 by reason of sec. 6211(b)(4). But under
our holding in Rand (and leaving aside the possible impact of the PATH Act
amendment), petitioners' "underpayment", for the purpose of computing accuracy-
related penalties, would have been limited to the $6,984 tax imposed on them.
The $3,000 refundable portion of petitioners' AOC would not have reduced the tax
shown on their return, for purposes of sec. 6664(a), below zero. Petitioners might
be suggesting that respondent's gratuitous payment to them of at least $516 would
have enabled him to increase their underpayment to $7,500, thereby increasing
their liability for an accuracy-related penalty. But respondent would not have
made the imagined payment on the ground that the tax imposed by subtitle A on
petitioners was less than !$516. Thus, the payment would not have been a
"rebate" within the meaning of either sec. 6211(b)(2) or 6664(a) (flush language)
and would not have affected the amount of petitioners' underpayment.
                                         -14-

Commissioner had reason to believe that the taxpayer was entitled to refundable

credits. Section 6211(b)(4) reflects Congress' intent to allow issues concerning

refundable credits to be litigated in this Court. Thus, we not only agree with the

parties that, in a typical case involving no rebates, the excess of the tax shown on a

taxpayer's return over rebates can be negative (and would be negative whenever

the tax shown is itself negative because of claimed refundable credits); we also see

no basis in either the text or purpose of the relevant rules for reaching a different

result in a case in which the Commissioner made a rebate to the taxpayer within

the meaning of section 6211(b)(2).

      D.     Conclusion

      For the reasons described above, we hold explicitly what was implicit in

several of our prior cases: the excess of the tax shown on a taxpayer's return over

rebates made, for the purpose of computing a deficiency, can be a negative

number, regardless of whether the Commissioner, in fact, made any rebates to the

taxpayer for the year in issue. Thus, the excess of the tax shown on a return over

rebates can be negative not only when rebates are zero, as was the case in Blore,

Wilson, and Voigt, but also when, as here, the Commissioner has made a rebate of

a positive amount.
                                        -15-

      Consequently, petitioners' deficiency for 2011, under the definition

provided in section 6211(a), is $7,500: the amount by which the $6,984 tax

imposed on them for that year under subtitle A exceeds !$516 (which, in turn, is

the excess of the tax shown on petitioners' 2011 return over the $4,500 rebate

made by respondent).

II.   Petitioners' Liability for the Accuracy-Related Penalty

      A.    Applicable Law

      Section 6662(a) and (b)(1) provides for an accuracy-related penalty of 20%

of the portion of an "underpayment" of tax attributable to negligence or disregard

of rules and regulations. Section 6662(a) and (b)(2) provides for the same penalty

on the portion of an underpayment of tax attributable to "[a]ny substantial

understatement of income tax."

      The definitions of "underpayment" and "understatement" provided in

sections 6664(a) and 6662(d)(2)(A), respectively, closely parallel the section

6211(a) definition of "deficiency". Section 6664(a) defines "underpayment" to

mean "the amount by which any tax imposed by this title exceeds the excess of--

(1) the sum of--(A) the amount shown as the tax by the taxpayer on his return, plus

(B) amounts not so shown previously assessed (or collected without assessment),

over (2) the amount of rebates made." For purposes of section 6664(a)(2), "the
                                          -16-

term 'rebate' means so much of an abatement, credit, refund, or other repayment, as

was made on the ground that the tax imposed was less than the excess of the

amount specified in * * * [section 6664(a)(1)] over the rebates previously made."

Sec. 6664(a) (flush language). Section 6662(d)(2)(A) defines the term

"understatement" to mean "the excess of--(I) the amount of tax required to be

shown on the return for the taxable year, over (ii) the amount of tax imposed

which is shown on the return, reduced by any rebate (within the meaning of

section 6211(b)(2))."

      In the case of an individual, an understatement of income tax is

"substantial" if it exceeds the greater of 10% of the tax required to be shown on

the return or $5,000. Sec. 6662(d)(1)(A). An understatement is reduced, however,

by the portion attributable to the treatment of an item for which the taxpayer had

"substantial authority" or, in the case of items adequately disclosed, a "reasonable

basis". Sec. 6662(d)(2)(B). A taxpayer's position has substantial authority if the

weight of the authorities in support of that position is substantial in the relation to

the weight of any contrary authorities. See sec. 1.6662-4(d)(3), Income Tax Regs.

Disclosure is adequate if it includes "the relevant facts affecting the item's tax

treatment". Sec. 6662(d)(2)(B)(ii)(I). Subject to exceptions provided in an annual

revenue procedure, disclosure must be made on a Form 8275 or, in the case of
                                        -17-

positions contrary to a regulation, a Form 8275-R. Sec. 1.6662-4(f)(1) and (2),

Income Tax Regs.; see also Rev. Proc. 2012-15, 2012-7 I.R.B. 369 (identifying

circumstances under which disclosure on a taxpayer's 2011 return is adequate for

purposes of reducing an understatement of income tax under section 6662(d)).

The "reasonable basis" standard is "a relatively high standard of tax reporting" that

generally requires a position to be "reasonably based" on relevant authorities. See

sec. 1.6662-3(b)(3), Income Tax Regs.

      Section 6664(c)(1) provides an exception to the imposition of the section

6662(a) accuracy-related penalty if it is shown that there was reasonable cause for

the underpayment and the taxpayer acted in good faith. Section 1.6664-4(b)(1),

Income Tax Regs., provides:

      The determination of whether a taxpayer acted with reasonable cause
      and in good faith is made on a case-by-case basis, taking into account
      all pertinent facts and circumstances. * * * Generally, the most
      important factor is the extent of the taxpayer's effort to assess the
      taxpayer's proper tax liability. Circumstances that may indicate
      reasonable cause and good faith include an honest misunderstanding
      of fact or law that is reasonable in light of all the facts and
      circumstances, including the experience, knowledge, and education of
      the taxpayer. * * *

      The Commissioner bears the burden of production with respect to penalties.

See sec. 7491(c). To meet that burden, he must produce evidence regarding the

appropriateness of imposing the penalty. Higbee v. Commissioner, 116 T.C. 438,
                                         -18-

446 (2001). If the Commissioner carries his burden of production, the taxpayer

then bears the burden of proving that he or she is entitled to relief because of

substantial authority or an adequately disclosed position with a reasonable basis,

or under section 6664(c)(1). See id.

      B.     Respondent's Satisfaction of His Burden of Production

      Respondent calculates petitioners' 2011 underpayment and understatement

to be $7,500, applying the same formula he uses to compute their deficiency for

that year. That is, according to respondent, petitioners' underpayment and

understatement is the tax imposed on petitioners for 2011 ($6,984) reduced by the

excess of the tax shown on their return ($3,984) over the rebate he made to them

for that year ($4,500). Respondent supports his calculation of petitioners'

underpayment by referring to prior cases in which we have implicitly accepted the

proposition that, in computing an underpayment, as in computing a deficiency, the

excess of the tax shown on a taxpayer's return over any rebates can be a negative

number. See Snow v. Commissioner, 141 T.C. 238 (2013); Sadler v.

Commissioner, 113 T.C. 99 (1999); Rice v. Commissioner, T.C. Memo. 1999-65.

      Petitioners initially argued that their underpayment for 2011 was limited to

$6,984 because the excess of the tax shown on their return over the rebate was

zero. Later, petitioners conceded that "the term 'excess' means the same in the
                                         -19-

definitions of underpayment and deficiency" and that "prior case law has allowed

the term to be a negative number when calculating underpayment."

      Although petitioners appear to accept that their underpayment for 2011 was

$7,500, they also seem to argue that, by contrast, their understatement is limited to

$3,000. According to petitioners: "Section 6662(a)(2) does not apply to * * *

[them] because the amount they actually sought as a refund on their return would

not satisfy the $5,000 statutory threshold. Had Respondent not issued the 'rebate'

refund on which he now seeks to penalize * * * [them], the amount of the

deficiency would be under the $5,000 threshold for penalty application." (We

assume that petitioners mean to refer to section 6662(b)(2) and to the amount of

their understatement, rather than their deficiency.)

      If petitioners are claiming that the $4,500 additional refund they received,

which they concede to have been a rebate, should not be included in the

calculation of their understatement, that claim is contrary to the statutory

definition of "understatement" provided in section 6662(d)(2)(A). Under that

definition, the amount of tax shown on a taxpayer's return is "reduced by any

rebate" before the net amount is compared to the tax imposed on the taxpayer.

Thus, by definition, rebates made to a taxpayer can increase the taxpayer's

understatement for purposes of the accuracy-related penalty. That does not raise
                                        -20-

the prospect of a taxpayer's being penalized for the Commissioner's actions.

Again, the Commissioner cannot at his whim pay refunds that qualify as rebates.

For a refund to meet the definition of "rebate", it must rest on a determination that

the tax imposed on a taxpayer is less than the tax shown on the taxpayer's return.

Secs. 6211(b)(2), 6664(a) (flush language). Any such determination would

generally rely on information submitted by the taxpayer.4 If the tax shown on a

taxpayer's return was fully consistent with all information provided to the

Commissioner, he would have no grounds for making a rebate. In the present

case, respondent made a $4,500 rebate to petitioners on the basis of their claim of

a $4,500 nonrefundable AOC on Form 8863 that they failed to carry to their Form

1040 in what appeared to be a clerical error.

      For the reasons explained above, we conclude that petitioners'

understatement for 2011 (before considering any reduction under section

      4
        In theory, the Commissioner might make a rebate on the basis of erroneous
third-party reporting that would increase the affected taxpayer's understatement for
purposes of the accuracy-related penalty. Were that to occur, the taxpayer should
be able to show that there was reasonable cause for the portion of his
underpayment attributable to the rebate and that he acted in good faith with respect
to that portion, as long as he did nothing to initiate the rebate and bore no
responsibility for the erroneous third-party reporting. Cf. sec. 6664(c)(1). In the
present case, because respondent made the rebate on the basis of petitioners'
erroneous reporting on their Form 8863, in assessing their reasonable cause
defense under sec. 6664(c)(1), we must consider the grounds for those actions of
petitioners that led to the rebate. See infra part II.C.2.
                                        -21-

6662(d)(2)(B)) equals their $7,500 underpayment for that year. Because that

amount exceeds $5,000 (which, in turn, is greater than 10% of the $6,984 tax

required to have been shown on their return), petitioner's understatement (unless

reduced under section 6662(d)(2)(B)) is a substantial understatement.

Consequently, respondent has met his burden of production in regard to the

accuracy-related penalty he determined.

      C.    Petitioners' Defenses

            1.     Reduction of Understatement Due to Substantial Authority or
                   Adequate Disclosure and Reasonable Basis

      Petitioners argue that, even if the rebate they received increases their

understatement, as defined by section 6662(d)(2)(A), their understatement is

nonetheless limited to $3,000 by reason of section 6662(d)(2)(B) (relating to

positions supported by substantial authority and adequately disclosed positions

with a reasonable basis). According to petitioners:

      [E]ven if the $4,500 is part of the understatement as an initial matter,
      it is removed from the understatement because there is or was
      substantial authority for the taxpayers' not claiming the nonrefundable
      portion of the credit. It was Respondent's position, not Petitioners',
      that Petitioners should receive a refund of the $4,500. Further, in the
      alternative * * * there was disclosure on the form that is used to
      calculate education credits and a reasonable basis for the taxpayers
      not to claim the $4,500 on the return.
                                         -22-

      We can readily dismiss petitioners' substantial authority and adequate

disclosure arguments. We do not view petitioners as having claimed only a

$3,000 refundable AOC: Their Form 8863 reported a total AOC of $7,500.

Petitioners are not subject to the accuracy-related penalty for their failure to claim

a $4,500 nonrefundable AOC on their Form 1040 but instead for their claim of

such a credit on their Form 8863. Because the refundable portion of the AOC is,

by definition, 40% of the total AOC to which a taxpayer is entitled, sec. 25A(i)(6),

claiming a $3,000 refundable AOC and no nonrefundable AOC cannot be

supported by substantial authority.

      Petitioners obviously failed to meet the standards for adequate disclosure of

their position in regard to the claimed AOC. Their 2011 return simply claimed the

credit without disclosing all of the facts relevant to their claim. Moreover, their

return included no Form 8275. Rev. Proc. 2012-15, supra, does not list the claim

of an AOC among the positions for which disclosure on the relevant form (without

a Form 8275 or Form 8275-R) constitutes adequate disclosure. Finally, petitioners

do not explain how the claim of a refundable AOC and no claim of a

nonrefundable AOC can possibly have a reasonable basis.

      Petitioners' understatement thus remains a substantial understatement after

taking into account section 6662(d)(2)(B). Because we conclude that petitioners'
                                        -23-

$7,500 underpayment was attributable to a substantial understatement of income

tax, we need not consider respondent's alternative argument that petitioners'

underpayment was also attributable to negligence.

              2.   Reasonable Cause and Good Faith

      Petitioners argue that they "acted reasonably and in good faith under the

circumstances and mistakenly believed that they were entitled to the credit at the

time of filing." They claim that "they attempted to follow the instructions of the

program used to self-prepare returns" but made a "mistake" that "was driven by

confusion".

      Respondent observes that petitioners' reporting of a refundable AOC on

their Form 1040 was inconsistent with their failure to claim any nonrefundable

AOC on that form and that this inconsistency "suggests that * * * [petitioners] did

not make much effort to determine their entitlement to any part of the credit."

Respondent further argues that petitioners' failure to return the excessive portion

of the refund they received, even after that excess had been brought to their

attention, demonstrates a lack of good faith.

      As noted above, under the regulations "an honest misunderstanding of * * *

law" can be an indication of reasonable cause and good faith, but only if that

misunderstanding "is reasonable in light of all the facts and circumstances". Sec.
                                         -24-

1.6664-4(b)(1), Income Tax Regs. Petitioners have not described for us the source

of their confusion or the nature of their mistake. Mr. Galloway conceded at trial,

without providing any explanation, that petitioners were not entitled to an AOC

for tuition or expenses paid on behalf of E.G. In their posttrial briefs, petitioners

have offered us no further elucidation of the basis for the belief, which they now

concede to have been mistaken, that they were entitled to any portion of the AOC

they claimed. Consequently, petitioners have not met their burden of proving the

existence of reasonable cause for any portion of the underpayment resulting from

respondent's disallowance of the claimed AOC.

      The limited record before us suggests that petitioners conceded the 2011

AOC they claimed for J.G. and G.G. because they had claimed AOCs for those

children for each of the four prior taxable years. Petitioners claimed an AOC for

2007 for qualified expenses of J.G. and G.G., each of whom completed an

undergraduate degree in 2011. We can reasonably surmise that petitioners also

claimed AOCs for J.G. and G.G. in each of 2008, 2009, and 2010. Had that been

the case, petitioners would not have been entitled to claim an AOC for J.G. and

G.G. for 2011 because of the four-taxable-year limitation provided in section

25A(b)(2)(A) and (i)(2). Perhaps petitioners were under the mistaken impression

that they could claim AOCs for each of their children for four academic years
                                        -25-

rather than four taxable years. Even if petitioners had established that that had

been the basis of their misunderstanding, however, we would not have viewed that

misunderstanding as reasonable under the circumstances.

      In assessing the reasonableness of a taxpayer's misunderstanding of the law

for the purpose of applying the reasonable cause exception to the accuracy-related

penalty, we have placed significant weight on the degree of clarity of the

applicable law. For example, we have accepted taxpayers' reasonable cause

defenses when the relevant law was uncertain or ambiguous. See Stromme v.

Commissioner, 138 T.C. 213, 222 (2012) ("Given the ambiguity in this area of the

law, we find the Strommes' confusion reasonable and honest."); Rolfs v.

Commissioner, 135 T.C. 471, 496 (2010) ("[G]iven all the facts and

circumstances, including the uncertain state of the law, we find that petitioners

acted with reasonable cause and in good faith."), aff'd on other grounds, 668 F.3d

888 (7th Cir. 2012). By contrast, in Remy v. Commissioner, T.C. Memo. 1997-72,

1997 WL 52446, we rejected the reasonable cause defense of a taxpayer who had

claimed a deduction that was contrary to settled law. The taxpayer in Remy was a

physician who had attempted to deduct as an advertising expense the value of

unpaid medical advice he provided by telephone. We accepted that the taxpayer

had "attempted to research the tax law to find authority for his position" and that
                                        -26-

"he took steps to accurately document the extent of his telephone services by

maintaining a log." Id., 1997 WL 52446, at *8. Nonetheless, we concluded that

"this is not enough to be relieved of the accuracy-related penalty." Id. Because of

"the weight of authority against * * * [the taxpayer's] position", we could not find

his position reasonable. Id. Remy thus stands for the proposition that a

misunderstanding of settled, unambiguous law cannot be "honest" or "reasonable"

within the meaning of section 1.6664-4(b)(1), Income Tax Regs.

      In the present case, any "confusion" petitioners might have had over their

entitlement to an AOC for J.G. and G.G. for a fifth taxable year would not have

been attributable to uncertainty or ambiguity in the relevant rules. The law

unambiguously provides that a credit can be claimed under section 25A for an

eligible student for only four taxable years. While the statutory provisions that

impose that limitation may not be a model of clarity and simplicity,5 the 2011

Instructions for Form 8863, which Mr. Galloway professed to have followed, state

clearly and unambiguously on their front page that the AOC is "Available ONLY

for 4 tax years per eligible student (including any year(s) Hope credit was

      5
        Sec. 25A(b)(2)(A) provides: "An election to have this section apply with
respect to any eligible student for purposes of the Hope Scholarship Credit under
subsection (a)(1) may not be made for any taxable year if such an election * * * is
in effect with respect to such student for any 2 prior taxable years." Sec. 25A(i)(2)
provides that sec. 25A(b)(2)(A) "shall be applied by substituting '4' for '2'."
                                         -27-

claimed)". Given the clear directive in the instructions to the 2011 Form 8863,

even if petitioners' alleged confusion related to the number of years for which they

could claim an education credit for each of their dependent children, that

confusion would not have been reasonable under the circumstances. Because

petitioners have not met their burden of establishing that they claimed the AOC in

issue on the basis of an honest misunderstanding of law that was reasonable under

the circumstances, we need not consider whether, as respondent alleges,

petitioners' failure to return the excessive portion of the refund they received

demonstrates a lack of good faith.

      D.     Conclusion

      Because respondent has met his burden of producing evidence that the

accuracy-related penalty he determined is appropriate, and because petitioners

have not met their burden of demonstrating their eligibility for relief from the

determined penalty, we sustain respondent's imposition of a $1,500 accuracy-

related penalty on petitioners for 2011 under section 6662(a) and (b)(2).


                                                      Decision will be entered

                                                for respondent.
