                           125 T.C. No. 10



                     UNITED STATES TAX COURT



ESTATE OF ROBERT J. CAPEHART, DECEASED, INGRID CAPEHART, PERSONAL
       REPRESENTATIVE, AND INGRID CAPEHART, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 9943-97.               Filed November 14, 2005.



          H & W filed a joint Federal income tax return for
     1994. R disallowed losses attributable equally to H &
     W. As a result of the disallowance of the losses, R
     also disallowed a deduction for medical/dental expenses
     claimed on the return. The parties agree that W is
     entitled to relief from liability pursuant to sec.
     6015(c), I.R.C. Consequently, W’s liability cannot
     exceed the portion of the deficiency properly allocable
     to her under sec. 6015(d), I.R.C. The parties disagree
     as to the amounts of the deficiency and the sec.
     6662(a), I.R.C., accuracy-related penalty for 1994 that
     are to be allocated to W under sec. 6015(d), I.R.C.

          1. Held: The disallowed medical/dental expenses
     are erroneous items that gave rise to a portion of the
     deficiency and must be allocated between H & W in
     determining the portion of the deficiency properly
     allocable to W under sec. 6015(d), I.R.C.
                              - 2 -

          2. Held, further, sec. 6015(d), I.R.C., does not
     limit the portion of the deficiency properly allocable
     to W to the amount of tax W would have owed had she
     filed a separate return.

          3. Held, further, sec. 6015(d), I.R.C., does not
     limit the portion of the deficiency properly allocable
     to W to W’s proportionate share of the taxable income
     properly reported on the joint return.

          4. Held, further, the erroneous items
     attributable to W are allocable to W under sec.
     6015(d), I.R.C., to the extent of W’s taxable income
     properly included on the joint return.

          5. Held, further, the alternative allocation
     method set forth in sec. 1.6015-3(d)(6)(i), Income Tax
     Regs., does not apply because erroneous deductions are
     not “erroneous items that are subject to tax at
     different rates”.

          6. Held, further, computation of the portions of
     the deficiency and the sec. 6662(a), I.R.C., accuracy-
     related penalty allocable to W for 1994 under sec.
     6015(d), I.R.C., determined.



     Terri A. Merriam, Wendy S. Pearson, and Jennifer A. Gellner,

for petitioners.

     Nhi T. Luu-Sanders, for respondent.
                                 - 3 -

                                OPINION


     JACOBS, Judge: Respondent determined the following

deficiency in petitioners’ Federal income tax and accuracy-

related penalties for 1994:1

                           Accuracy-Related Penalty
                      Sec.       Sec.      Sec.      Sec.
     Deficiency      6662(h)    6662(e)   6662(d)   6662(c)

         $17,059     $6,823      $3,411   $3,411    $3,411

     In the second amendment to petition, Ingrid Capehart

(petitioner) elected and requested relief from tax liability

under section 6015(b), (c), and (f).

     The parties have filed a stipulation of settled issues and a

stipulation of facts.   In the stipulation of settled issues the

parties have settled the substantive issues for determining the

deficiency and the penalties.    The parties agree that petitioners

have a Federal income tax deficiency of $8,225 and are liable for

an accuracy-related penalty under section 6662(a) in the amount

of $507 for 1994.   In addition, petitioner no longer seeks relief

under section 6015(b) and (f), and respondent agrees that

petitioner is entitled to relief under section 6015(c).




     1
      Unless otherwise indicated, section references are to the
Internal Revenue Code in effect at all relevant times.
                               - 4 -

     The sole issue for decision concerns the computation of the

portion of the deficiency and the accuracy-related penalty for

1994 allocable to petitioner under section 6015(d).

                            Background

      The facts in this case have been stipulated and are found

accordingly.   The stipulation of settled issues, the stipulation

of facts, and the exhibits submitted therewith are incorporated

herein by this reference.

     When the petition in this case was filed, petitioner and her

husband, Robert J. Capehart (Mr. Capehart), resided in Sparks,

Nevada.   Mr. Capehart died on January 23, 2002, after the

petition in this case was filed.   The Estate of Robert J.

Capehart, Deceased, has been substituted as a party.   Petitioner

is the personal representative of Mr. Capehart’s estate.

     On April 15, 1995, Mr. Capehart and petitioner filed a joint

Federal income tax return for 1994 on which they reported the

following:
                             - 5 -

Item                                            Amount

Income
  Wages, salaries, tips, etc.        $52,071
  Interest                               473
  Dividends                              135
  State tax refund                       373
  Capital gain                           190
  Other gain or loss (Form 4797)     (37,239)
  Pension                             12,426
  Gambling income                      2,458
Adjustments to income
  Mr. Capehart’s IRA deduction        (1,200)
  Petitioner’s IRA deduction          (1,200)
Adjusted gross income                                    $28,487
Itemized deductions (Schedule A)
  Medical/dental1                       1,143
  State income taxes                      442
  Real estate taxes                       907
  Personal property taxes                 504
  Mortgage interest                     4,164
  Charitable gifts                        180
  Theft loss                            4,183
  Gambling losses                       2,458
    Total                                                (13,981)
Net income                                                14,506
Exemptions                                                (4,900)
Taxable income                                             9,606
Tax                                                        1,444
Federal income tax withheld2                               7,132
Refund                                                     5,688
       1
      Petitioner and Mr. Capehart reported total
medical/dental expenses of $3,280 and deducted the excess
over $2,137 (7.5 percent of their $28,487 adjusted gross
income).
       2
      Petitioner had Federal income tax of $2,164 withheld
from her wages. Mr. Capehart had Federal income tax of
$4,968 withheld from his wages and retirement income.
                               - 6 -

     Respondent did not refund the $5,688 overpayment reflected

on the joint return but instead issued a “pre-filing notification

letter” that the refund was “suspended”.

     Respondent issued petitioner and Mr. Capehart a notice of

deficiency dated March 28, 1997.   In the notice of deficiency,

respondent, inter alia, disallowed the $37,239 loss claimed on

Form 4797, Sale of Business Property (the Form 4797 loss), and

the $4,183 theft loss claimed on the return.    Petitioners now

agree that they are not entitled to deduct these losses in 1994.

The Form 4797 loss and the theft loss are related to petitioner’s

and Mr. Capehart’s participation in a partnership formed,

promoted, and operated by Walter J. Hoyt III.    These losses are

attributable equally to petitioner and Mr. Capehart.

                            Discussion

     As a general rule, spouses filing joint Federal income tax

returns are jointly and severally liable for all taxes due.    Sec.

6013(d)(3).   Section 6015 provides three alternative grounds for

granting relief from joint and several liability.    First, section

6015(b) provides for traditional relief from joint and several

liability for a tax deficiency following the model of former

section 6013(e).   Second, section 6015(c) provides for an

allocation of liability for a tax deficiency.    Finally, section

6015(f) provides for relief from liability for any unpaid tax or
                               - 7 -

deficiency on equitable grounds, but only if section 6015(b) and

(c) does not apply.

     Under section 6015(c)(3), if spouses who filed a joint

return are no longer married or are legally separated, then the

requesting spouse may elect to limit his/her liability to the

portion of the deficiency allocated to him/her as provided in

section 6015(d).   The deficiency is determined from the joint

return on the basis of the married filing joint return status

(the rate elected by the spouses when they filed the joint

return).   The electing spouse generally bears the burden of proof

with respect to establishing the portion of any deficiency that

is allocable to him/her.   Sec. 6015(c)(2).

     The parties agree that petitioners have a deficiency in

their 1994 Federal income tax of $8,225 and are liable for an

accuracy-related penalty under section 6662(a) of $507.    They

also agree that petitioner qualifies for relief under section

6015(c).   The parties disagree as to the amounts of the

deficiency and the penalty for which petitioner is liable

pursuant to section 6015(d).

A.   Proportionate Allocation Method

     Generally the portion of the deficiency on a joint return

allocated to an individual is the amount that bears the same

ratio to the deficiency as the net amount of items taken into

account in computing the deficiency and allocable to the
                                - 8 -

individual under section 6015(d)(3) bears to the net amount of

all items taken into account in computing the deficiency.      Sec.

6015(d)(1).    Section 6015(d)(3)(A) provides that items giving

rise to a deficiency on a joint return (erroneous items) shall be

allocated to each spouse as though each had filed a separate

return for the taxable year; i.e., an erroneous item is allocated

to the spouse to whom the erroneous item is attributed.    The

requesting spouse is liable only for his/her proportionate share

of the deficiency; i.e., the amount that bears the same ratio to

the deficiency as the net amount of erroneous items allocable to

the electing spouse bears to the net amount of all erroneous

items.    Sec. 6015(d)(1), (3)(A); sec. 1.6015-3(d)(4)(A), Income

Tax Regs.

     1.     Allocation of Erroneous Items

     The parties agree that the Form 4797 loss and the theft loss

are “erroneous items” that are attributable equally to Mr.

Capehart and petitioner; i.e., had petitioner and Mr. Capehart

filed separate returns, they would each have reported one-half of

the losses on their respective separate returns.    See sec.

1.6015-3(d)(2)(iv), Income Tax Regs.

     The parties’ computations reveal that petitioners are not

entitled to any deduction for medical or dental expenses.

Petitioner and Mr. Capehart reported total medical/dental

expenses of $3,280 and deducted $1,143 on the joint return on
                                - 9 -

account of the 7.5-percent floor.   See sec. 213(a).   Their agreed

proper adjusted gross income is $65,668.   Only medical and dental

expenses exceeding 7.5 percent ($4,925.10) of the adjusted gross

income are deductible.   Since the amount of petitioners’ medical

and dental expenses ($3,280) did not exceed the threshold amount

($4,925.10), petitioners are not entitled to any deduction for

medical/dental expenses.   Consequently, the $1,143 medical/dental

expense deducted on the joint return is an erroneous item giving

rise to part of the deficiency for 1994.

     The parties have not informed the Court as to how petitioner

and Mr. Capehart would have reported the $1,143 of medical/dental

expenses if they had filed separate returns.    The regulations

provide that deduction items such as medical and dental expenses

that are unrelated to a business or investment are generally

allocated 50 percent to each spouse unless the evidence shows

that a different allocation is appropriate.    Sec. 1.6015-

3(d)(2)(iv), Income Tax Regs.   Thus, we will allocate $571.50 of

the disallowed medical and dental expenses to each of petitioner

and Mr. Capehart.2



     2
      We are mindful that because the amounts of the erroneous
Form 4797 loss and the theft loss attributed to petitioner exceed
her share of the spouses’ combined taxable income for 1994, the
portion of the deficiency for which petitioner remains liable
would be the same if all of the medical/dental expenses were
allocated to Mr. Capehart. Failure to include the disallowed
medical/dental expenses in the erroneous items, however, would
                                                   (continued...)
                               - 10 -

     The erroneous items giving rise to the 1994 tax deficiency

total $42,565 ($37,239 Form 4797 loss + $4,183 theft loss +

$1,143 medical/dental expenses) and are attributed equally to

petitioner and Mr. Capehart; i.e., $21,282.50 to each.     We refer

to the erroneous items attributed to petitioner and Mr. Capehart

respectively as her or his erroneous items.   Since all erroneous

items giving rise to the deficiency for 1994 are attributed

equally to petitioner and Mr. Capehart, under the general rule,

petitioner would be liable for one-half of the deficiency

($4,112.50).   See sec. 6015(d)(1), (3)(A); sec. 1.6015-

3(d)(4)(i)(A), Income Tax Regs.

     2.   Tax Benefit Exception

     Section 6015(d)(3)(B) provides an exception to the general

rule under section 6015(d)(3)(A) that an item giving rise to a

deficiency on a joint return is allocated to the spouses filing a

joint return in the same manner as it would have been allocated

if the spouses had filed separate returns for the taxable year.

Section 6015(d)(3)(B) provides that, under rules prescribed by

the Secretary, an item giving rise to a deficiency that is

attributable to one spouse must be allocated to the other spouse

“to the extent the item gave rise to a tax benefit on the joint

return” to the other spouse.   In essence, section 6015(d)(3)(B)


     2
      (...continued)
increase the portion of the deficiency for which petitioner would
remain liable.
                               - 11 -

provides for the reallocation of erroneous items to the extent

one spouse received a tax benefit on a joint return and the other

spouse did not.

     The Secretary has promulgated regulations prescribing such

rules.3   Section 1.6015-3(d)(2)(i), Income Tax Regs., provides:

“An erroneous item that would otherwise be allocated to the

nonrequesting spouse is allocated to the requesting spouse to the

extent that the requesting spouse received a tax benefit on the

joint return.”    This rule applies equally to items that would

otherwise be allocated to the requesting spouse.    Hopkins v.

Commissioner, 121 T.C. 73, 82-86 (2003).    Section 1.6015-3(d)(5),

Example (5), Income Tax Regs., provides:

          Example (5). Requesting spouse receives a benefit
     on the joint return from the nonrequesting spouse’s
     erroneous item. (i) In 2001, H reports gross income of
     $4,000 from his business on Schedule C, and W reports
     $50,000 of wage income. On their 2001 joint Federal
     income tax return, H deducts $20,000 of business
     expenses resulting in a net loss from his business of
     $16,000. H and W divorce in September 2002, and on May
     22, 2003, a $5,200 deficiency is assessed with respect
     to their 2001 joint return. W elects to allocate the
     deficiency. The deficiency on the joint return results
     from a disallowance of all of H’s $20,000 of
     deductions.

          (ii) Since H used only $4,000 of the disallowed
     deductions to offset gross income from his business, W
     benefitted from the other $16,000 of the disallowed


     3
      The regulations are applicable for all elections or
requests for relief filed on or after July 18, 2002. Sec.
1.6015-9, Income Tax Regs. In the case at bar, petitioner
elected relief in the second amendment to petition filed on May
22, 2003.
                                - 12 -

      deductions used to offset her wage income. Therefore,
      $4,000 of the disallowed deductions are allocable to H
      and $16,000 of the disallowed deductions are allocable
      to W. W’s liability is limited to $4,160 (4/5 of
      $5,200). * * *

      In sum, section 6015(d)(3)(A) and (B) and the applicable

regulations require the amount of deductions from the erroneous

items attributed to an individual to be first allocated to that

individual to the extent of the income reported on the joint

return that would have been allocated to that individual had

he/she filed a separate return.     Hopkins v. Commissioner, supra

at 82-86.   The excess of the amount of the deduction from the

erroneous items attributed to an individual over his/her share of

income reported on the joint return may give rise to a tax

benefit on the joint return to that individual’s spouse by

offsetting the income reported on the joint return that the

spouse would have reported had he/she filed a separate return.

Id.   Consequently, such excess is allocated to the individual’s

spouse to the extent it reduces the spouse’s share of income

reported on the joint return.     Id.

      The parties agree that, for purposes of section 6015(c) and

(d), items of income, loss/credit, and taxable income reported on

petitioners’ 1994 joint return should be allocated between

petitioner and Mr. Capehart as follows:
                             - 13 -

            Item           Petitioner     Mr. Capehart    Total

   Income
    Wages                  $20,146.00      $31,925.00    $52,071
    Interest                   236.50          236.50        473
    Dividends                   67.50           67.50        135
    State income tax           186.50          186.50        373
    Capital gains               95.00           95.00        190
    Pension                     -0-         12,426.00     12,426
    Gambling income          1,229.00        1,229.00      2,458
   Adjustments to income
    IRA deductions          (1,200.00)      (1,200.00)    (2,400)
   Adjusted gross income     20,760.50      44,965.50     65,726
   Itemized deduction
    State income tax            -0-            442.00        442
    Real estate taxes          453.50          453.50        907
    Personal property          252.00          252.00        504
    Mortgage interest        2,082.00        2,082.00      4,164
    Charitable                  90.00           90.00        180
    Gambling loss            1,229.00        1,229.00      2,458
   Exemption amount          2,450.00        2,450.00      4,900
      Total deductions       6,556.50        6,998.50     13,555
   Taxable income           14,204.00       37,967.00     52,171

     In accordance with section 6015(d) and the applicable

regulations, petitioner’s erroneous items ($21,282.50) are first

allocated to petitioner to the extent of the $14,204 of income

reported on the joint return that would have been allocated to

her had she filed a separate return.     The $7,078.50 excess of

petitioner’s erroneous items over her share of the income

reported on the joint return is then allocated to Mr. Capehart.

     3.   Proportionate Allocation of Deficiency

     Pursuant to section 6015(d)(1), the portion of the

deficiency allocable to petitioner is the amount that bears the

same ratio to the deficiency as the net amount of erroneous items
                               - 14 -

allocable to petitioner bears to the net amount of all erroneous

items taken into account in computing the deficiency.     The

proportionate allocation can be algebraically expressed as

follows:

                          net amount of erroneous items
       X = deficiency x      allocable to the spouse
                        net amount of all erroneous items

where X is the portion of the deficiency allocable to petitioner.

See sec. 1.6015-3(d)(4)(i)(A), Income Tax Regs.

     Under the proportionate allocation method, $2,744.69 is the

portion of the $8,225 deficiency allocable to petitioner,

computed as follows:

                $2,744.69 = $8,225 x $14,204
                                     $42,565

           a.    Respondent’s Computation

     Respondent computed petitioner’s share of the deficiency to

be $2,820.   Respondent computed petitioner’s share of the

deficiency by applying the proportionate allocation method

required by section 6015(d) to the Form 4797 loss and the theft

loss ($2,820 = $8,225 x $14,204 ÷ $41,422).    Respondent’s

computation is flawed in that it does not take into account the

$1,143 disallowed deduction for medical/dental expenses.
                                - 15 -

           b.     Petitioner’s Computation

                  i.   Separate Return Liability

     Petitioner asserts that her liability should be limited to

$2,134, the amount she would have paid on taxable income of

$14,204 had she filed a separate return.     Petitioner’s theory

assumes that erroneous items cannot be allocated in a way that

would result in a spouse’s owing more tax than if separate

returns had been filed.     Neither the statute nor the regulations

provide for such a limitation.     The statute and the regulations

allocate all of petitioner’s erroneous items to her except for

those items that provided a tax benefit to Mr. Capehart on the

joint return.     If petitioner’s liability were limited to $2,134,

then only $11,044 (not $14,204) of her erroneous items would be

allocated to her for purposes of section 6015(d)(1), computed as

follows:

          deficiency allocated
     X = to petitioner ($2,134) x total erroneous items($42,565)
          deficiency ($8,225)

where X is the portion of the erroneous items allocable to

petitioner.     Essentially, petitioner argues that Mr. Capehart

received a tax benefit on the joint return from $10,238.50 of

petitioner’s erroneous items.

      Under petitioner’s theory, Mr. Capehart’s $37,967 taxable

income would have been offset by his erroneous items ($21,282.50)

plus $10,238.50 of petitioner’s erroneous items.     The $9,606 of
                              - 16 -

taxable income reported on the return would have consisted of

$3,160 ($14,204 - $11,044) of petitioner’s taxable income and

$6,446 of Mr. Capehart’s taxable income.

     Petitioner’s theory is flawed.    Had petitioner and Mr.

Capehart filed separate returns that included the erroneous

items, petitioner would have reported no taxable income because

$14,204 of her $21,282.50 erroneous items would have offset all

of her income, and $7,078.50 of her erroneous items would have

been unused in 1994.   Consequently, she received the tax benefit

of $14,204 of her erroneous items.     Moreover, Mr. Capehart would

have reported taxable income of $16,684.50, the excess of his

taxable income over his erroneous items ($37,967 - $21,282.50).

Consequently, if petitioner and Mr. Capehart had filed separate

returns, on a pro forma basis their combined taxable income would

be $16,684.50 that would be solely attributable to Mr. Capehart.

Since petitioner and Mr. Capehart reported $9,606 of taxable

income on their joint return for 1994, Mr. Capehart’s share of

the taxable income was offset by $7,078.50 ($16,684.50 - $9,606)

of petitioner’s erroneous items that were reported on the joint

return.   Therefore, $7,078.50, not $10,238.50, of petitioner’s

erroneous items gave rise to a tax benefit on the 1994 joint

return to Mr. Capehart.   Consequently, only $7,078.50, not

$10,238.50, of petitioner’s erroneous items is allocated to Mr.

Capehart under section 6015(d)(3), and $14,204 of petitioner’s
                               - 17 -

erroneous items remains allocated to her, not the $11,044 that

petitioner’s theory would allocate to her.

               ii.    Benefit of Lower Tax Rate

     Petitioner posits that the proportionate allocation method

provided in section 1.6015-3(d)(4)(i)(A), Income Tax Regs., is

invalid because it does not account for the difference in the tax

rates as applied to petitioner’s and Mr. Capehart’s separate

taxable incomes.   Petitioner contends that Mr. Capehart would

have owed tax of $8,723 had he filed a separate return:     $19,000

of taxable income taxed at the rate of 15 percent and $18,677 of

taxable income taxed at the rate of 28 percent.4    Petitioner

asserts that her erroneous items provided a tax benefit on the

1994 joint return to Mr. Capehart because Mr. Capehart’s $37,967

of taxable income would have been taxable at an effective rate of

21.5 percent, rather than 15 percent.   Petitioner has not

provided a computation of the portion of her erroneous items that

provided the asserted benefit to Mr. Capehart.     Furthermore,

petitioner’s erroneous items did not reduce Mr. Capehart’s

effective tax rate.

     Mr. Capehart’s $37,967 of taxable income was offset by

$21,282.50 of erroneous items attributed to him.     The $16,684.50



     4
      Petitioner’s computation is in error in that it attributes
$37,677 ($19,000 + $18,677) of taxable income to Mr. Capehart.
Mr. Capehart had $37,967 of taxable income. Consequently,
$18,967 of his income would be taxable at the rate of 28 percent.
                              - 18 -

excess was taxable at 15 percent.    The amount of that excess plus

petitioner’s $14,204 of taxable income totaled $30,888.50.    For

married individuals who filed a joint return for 1994, only

taxable income in excess of $38,000 would have been taxed at a

rate greater than 15 percent rate.     Thus, contrary to

petitioner’s assertions, it was not her erroneous items that

reduced Mr. Capehart’s tax rate, but rather it was Mr. Capehart’s

erroneous items that reduced his tax rate.

     Because petitioner was unable to compute the portion of her

erroneous items that provided the asserted benefit to Mr.

Capehart, and because Mr. Capehart’s tax rate was not reduced by

petitioner’s erroneous items that were allocated to Mr. Capehart

pursuant to the formula set forth in section 1.6015-

3(d)(4)(i)(A), Income Tax Regs., petitioner has not shown that

the regulation is invalid.

               iii. Proportionate to Taxable Income

     Petitioner also complains that, while her 1994 taxable

income was only 27 percent of the total taxable income for 1994,

the proportionate allocation method provided in section 1.6015-

3(d)(4)(i)(A), Income Tax Regs., allocates 34 percent of the

deficiency to her.   The succinct response to petitioner’s

complaint is that Congress did not allocate the deficiency in

proportion to the spouses’ respective shares of taxable income

when formulating the relief to be granted under section 6015(c).
                              - 19 -

Section 6015(d) expressly requires that the allocation of the

deficiency be proportionate to the items taken into account in

determining the deficiency; i.e., proportionate to the erroneous

items allocated to the spouse, not to the spouse’s share of

taxable income.   A spouse’s taxable income is relevant for

purposes of allocating the erroneous items between the spouses

only where one spouse receives a tax benefit on the joint return

from the other spouse’s erroneous items.

B.   Alternative Allocation Method

     Section 6015(h) directs the Secretary to prescribe

regulations providing methods for allocation of items other than

the methods under section 6015(d)(3).5   Petitioner argues that

her liability should be limited to 15 percent of her taxable

income pursuant to section 1.6015-3(d)(6)(i) and (ii) Income Tax

Regs., which provides the following alternative method for

allocating a deficiency that arises from erroneous items that are




     5
      Sec. 1.6015-3(d)(4)(i)(B), Income Tax Regs., requires
application of the proportionate allocation method to any portion
of the deficiency other than any portion of the deficiency (1)
attributable to erroneous items allocable to the nonrequesting
spouse of which the requesting spouse had actual knowledge, (2)
attributable to separate treatment items (as defined in sec.
1.6015-3(d)(4)(ii), Income Tax Regs.), (3) relating to the
liability of a child (as defined in sec. 1.6015-3(d)(4)(iii),
Income Tax Regs.) of the requesting spouse or nonrequesting
spouse, (4) attributable to alternative minimum tax under sec.
55, (5) attributable to accuracy-related or fraud penalties, or
(6) allocated pursuant to alternative allocation methods
authorized under sec. 1.6015-3(d)(6), Income Tax Regs.
                             - 20 -

subject to tax at different rates, with an example demonstrating

the method:

          (6) Alternative allocation methods.--(i)
     Allocation based on applicable tax rates.--If a
     deficiency arises from two or more erroneous items that
     are subject to tax at different rates (e.g., ordinary
     income and capital gain items), the deficiency will be
     allocated after first separating the erroneous items
     into categories according to their applicable tax rate.
     After all erroneous items are categorized, a separate
     allocation is made with respect to each tax rate
     category using the proportionate allocation method of
     paragraph (d)(4) of this section.

               *    *    *    *    *    *    *

               (iii) Example.--The following example
     illustrates the rules of this paragraph (d)(6):

          Example. Allocation based on applicable tax
     rates. H and W timely file their 1998 joint Federal
     income tax return. H and W divorce in 1999. On July
     13, 2001, a $5,100 deficiency is assessed with respect
     to H’s and W’s 1998 return. Of this deficiency, $2,000
     results from unreported capital gain of $6,000 that is
     attributable to W and $4,000 of capital gain that is
     attributable to H (both gains being subject to tax at
     the 20% marginal rate). The remaining $3,100 of the
     deficiency is attributable to $10,000 of unreported
     dividend income of H that is subject to tax at a
     marginal rate of 31%. H and W both timely elect to
     allocate the deficiency, and qualify under this section
     to do so. There are erroneous items subject to
     different tax rates; thus, the alternative allocation
     method of this paragraph (d)(6) applies. The three
     erroneous items are first categorized according to
     their applicable tax rates, then allocated. Of the
     total amount of 20% tax rate items ($10,000), 60% is
     allocable to W and 40% is allocable to H. Therefore,
     60% of the $2,000 deficiency attributable to these
     items (or $1,200) is allocated to W. The remaining 40%
     of this portion of the deficiency ($800) is allocated
     to H. The only 31% tax rate item is allocable to H.
     Accordingly, H is liable for $3,900 of the deficiency
     ($800+$3,100), and W is liable for the remaining
     $1,200.
                              - 21 -

     The alternative method applies when the erroneous items are

subject to tax at different rates.     The erroneous items in this

case are the Form 4797 loss, the theft loss, and the

medical/dental expenses.   Those items are not subject to tax at

different rates.   Rather, they are all deductions used by

petitioner and Mr. Capehart on their joint return to offset

ordinary income.   Accordingly, section 1.6015-3(d)(6)(i) and (ii)

Income Tax Regs., does not change the result in this case.

C.   Allocation of Accuracy-Related Penalty

     Section 6662(a) imposes an accuracy-related penalty equal to

20 percent of the underpayment of tax.    The parties agree that

petitioners are liable for an accuracy-related penalty under

section 6662(a) of $507 computed on an underpayment of $2,537.

     For purposes of section 6662, the term “underpayment” is

defined by section 6664(a) to mean the amount by which the tax

imposed 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.   In essence, an underpayment for

purposes of section 6662 has the same meaning as a deficiency.

See secs. 6211(a), 6664(a); Downing v. Commissioner, T.C. Memo.

2005-73, supplementing T.C. Memo. 2003-347; Estate of Johnson v.

Commissioner, T.C. Memo. 2001-182, affd. 129 Fed. Appx. 597 (11th

Cir. 2005); Rice v. Commissioner, T.C. Memo. 1999-65.
                                - 22 -

     In the case at bar, the parties calculated the underpayment

by subtracting the $5,688 overpayment (the $7,132 withholding tax

paid less the $1,444 tax liability reported on the return)

claimed on the joint return, which was not refunded to

petitioners, from the $8,225 deficiency; i.e., a $2,537 balance

of tax remaining unpaid.6

     1.   Respondent’s Computation

     Respondent allocated $209 of the accuracy-related penalty to

petitioner.   In so doing, respondent allocated $1,774 of the

refund claimed to petitioner.    Respondent explained his

computation as follows:

          In computing the underpayment for purposes of the
     accuracy related penalty, respondent gave petitioner
     Ingrid Capehart credit for a frozen refund in the
     amount of $1,774.00. The frozen refund relates to
     Ingrid Capehart’s Federal income tax withholdings
     (prepayment credits) in the amount of $2,164.00 that
     were taken from her wages, reported on the return, and
     not refunded. In arriving at the $1,774.00 figure,
     respondent subtracted from Ingrid Capehart’s
     withholdings of $2,164.00 her allocable share of the
     $1,444.00 of tax liability reported on the 1994 return.
     Petitioner Ingrid Capehart’s allocable share of the
     $1,444.00 tax liability reported on the 1994 return is
     27 percent of $1,444.00 or $390.00 ($1,444.00 x .27 =
     $4390.00). 27 percent is used because this is the
     percentage of the total taxable income reported on the
     return that would have been allocated to Ingrid
     Capehart if the parties had filed separate returns. * *
     * Accordingly, the $1,774.00 figure was arrived at as
     follows:




     6
      Essentially, the parties treat the claimed refund amount of
withholding tax as a tax collected without assessment.
                              - 23 -

            $2,164.00    Withholding credits
          - $ 390.00     Ingrid Capehart’s allocable share
                         of the $1,444.00 liability report
                         on the return
            $1,774.00    Frozen Refund Credit

     Respondent computed petitioner’s share of the accuracy-

related penalty as follows:

     Petitioner’s share of deficiency as
       computed by respondent                   $2,820
     Petitioner’s frozen refund credit          (1,774)
     Petitioner’s underpayment upon which
       the accuracy-related penalty applies      1,046
     Accuracy-related penalty percentage        x 0.20
                                                   209

     2.   Petitioner’s Position

     Petitioner erroneously refers to the $1,444 tax shown on the

return as the tax “paid” on the return and complains that

respondent allocated only $390 of that tax to her in computing

her share of the accuracy-related penalty.    The gist of

petitioner’s complaint is that the $390 of tax allocated to her

represents 27 percent of the tax “paid” on the return ($1,444),

whereas the $209 of the section 6662(c) penalty allocated to her

is 41 percent of the total section 6662(a) penalty.

     3.   Computation of Petitioner’s Share of the Accuracy-
          Related Penalty

     Section 1.6015-3(d)(4)(iv)(B), Income Tax Regs., provides

that the accuracy-related penalty under section 6662 is

“allocated to the spouse whose item generated the penalty.”    As

we have previously discussed, the erroneous items allocated to

petitioner offset all of her taxable income reported on the joint
                              - 24 -

return.   The $9,606 of taxable income reported on the return upon

which the tax reported on the return was calculated was Mr.

Capehart’s income that was not offset by the erroneous items

allocated to him.   We conclude, therefore, that the $1,444 tax

reported on the return should not be included in computing the

portion of the underpayment attributable to petitioner.

     Any portion of the tax shown on the return that is allocated

to petitioner reduces the amount of her withholding credits to be

applied toward her portion of the tax deficiency and increases

her share of the underpayment.   Consequently, allocating a

portion of the tax shown on the return to petitioner increases

her portion of the accuracy-related penalty.   Taking into account

the proper allocation of the erroneous items, we do not think

that it is proper to allocate any of the tax shown on the return

to petitioner.

     On the basis of the taxable income and erroneous items, the

total tax liability and the portion not offset by withholding

credits (unpaid taxes) is allocated between petitioner and Mr.

Capehart as follows:
                             - 25 -

     Item                  Petitioner   Mr. Capehart     Total

   Taxable income           $14,204       $37,967      $52,171
   Erroneous items          (14,204)      (28,361)     (42,565)
   Taxable income on           -0-          9,606        9,606

   Tax on return                            1,444        1,444
   Tax deficiency             2,745         5,480        8,225
   Total tax liability        2,745         6,924        9,669
   Withholding               (2,164)       (4,968)      (7,132)
   Unpaid tax                   581         1,956        2,537

     Treating the withholding tax paid in excess of the liability

as a tax collected without assessment for purposes of section

6662, the underpayment of tax is allocated between petitioner and

Mr. Capehart as follows:

   Item                    Petitioner   Mr. Capehart     Total

 Tax imposed                 $2,745        $6,924       $9,669
 Tax on return                 -0-         (1,444)      (1,444)
 Tax collected without
  assessment                 (2,164)       (3,524)      (5,688)
 Underpayment                   581         1,956        2,537

     We reach the same result by applying respondent’s method of

computing the underpayment without allocating any portion of the

$1,444 of tax reported on the return to petitioner, shown as

follows:

     Petitioner’s withholding                          $2,164
     Petitioner’s allocable share of the
       $1,444 liability report on the return             -0-
     Petitioner’s frozen refund credit                  2,164
     Petitioner’s share of deficiency                   2,745
     Petitioner’s frozen refund credit                 (2,164)
     Petitioner’s underpayment upon which
       the accuracy-related penalty applies               581
                             - 26 -

     We conclude that the underpayment generated by petitioner’s

erroneous items is $581 and the penalty allocated to petitioner

is $116 ($581 x 0.20).

D.   Conclusion

     We hold that pursuant to section 6015(c) petitioner remains

jointly and severally liable for $2,745 of the deficiency and

$116 of the accuracy-related penalty under section 6662.

     In accordance with the above,


                                          An appropriate decision

                                     will be entered.
