                                     T.C. Memo. 1996-210



                                 UNITED STATES TAX COURT



                   MARK J. AND DEBORAH A. HANNA, Petitioners v.
                   COMMISSIONER OF INTERNAL REVENUE, Respondent



       Docket No. 2995-95.                                            Filed May 1, 1996.



       Charles F. Daily, Jr., for petitioners.

       Steven B. Bass, for respondent.


                        MEMORANDUM FINDINGS OF FACT AND OPINION

       COHEN, Judge:            Respondent determined additions to tax and a

penalty in petitioners’ Federal income taxes as follows:

                                   Additions to Tax and Penalty
       Sec.               Sec.            Sec.           Sec.           Sec.    Sec.
Year   6651(a)(1)         6653(a)(1)(A)   6653(a(1)(B)   6653(a)(1)     6661    6662(a)
                                               1
1987        $     413       $1,837                            --       $2,064     --
1988            4,187         --               --          $3,663       4,188     --
1989            9,491         --               --             --          --    $7,593
       1
           Plus 50 percent of the interest due on $8,257.
                                - 2 -

Unless otherwise indicated, all section references are to the

Internal Revenue Code for the years in issue, and all Rule

references are to the Tax Court Rules of Practice and Procedure.

The issues for decision are whether petitioners are liable for

the additions to tax and penalty determined by respondent.

                           FINDINGS OF FACT

     Some of the facts have been stipulated, and the stipulated

facts are incorporated in our findings by this reference.    At the

time the petition was filed, petitioners resided in Austin,

Texas.

     Mark J. Hanna (Mr. Hanna) was an attorney for Babb & Hanna,

P.C. (Babb & Hanna), during the years in issue.    Deborah A. Hanna

(Mrs. Hanna) worked in the real estate business and as a

consultant for Babb & Hanna during the years in issue.

     Petitioners requested and received extensions to October 15,

1988, to file their 1987 income tax return.    The 1987 return was

signed by them October 15, 1988.    It was mailed on or after

October 15, 1988, but was returned for insufficient postage.    It

was thereafter remailed.    The envelope in which the 1987 return

was received was not retained by the Internal Revenue Service

(IRS).   The return was stamped by the IRS, however, showing the

postmark date of the return as October 31, 1988, and the received

date of the return as November 3, 1988.

     On their 1987 return, petitioners reported adjusted gross

income in the amount of $190,280.08.    In late 1988, the IRS
                                 - 3 -

issued a delinquency penalty notice to petitioners concerning

their 1987 return.   Petitioners paid without protest the amount

shown on the notice.

      Petitioners requested and received extensions to

October 15, 1989, to file their 1988 income tax return.

Petitioners included a $20,000 payment with their original

request for extension.   IRS records do not indicate that

petitioners received an additional extension of time to file

their 1988 return.

     Beginning in March 1990, Mr. Hanna was involved in

litigation with his former business partner.    Due to the pending

litigation, Mr. Hanna was denied access to his tax records that

were located on the premises of his former business office.

     On April 16, 1990, petitioners sent an additional $25,000

check on their 1988 tax liability to the IRS.    Petitioners

stopped payment on the check, however, based on a District Court

order (court order) related to the litigation.    Petitioners’ 1988

return was filed on October 17, 1990, and did not have attached

an original extension request.    Petitioners' 1988 return reported

adjusted gross income of $254,374.46 and indicated additional

taxes owed of $21,513.99.

     Petitioners also requested and were granted an extension to

October 15, 1990, to file petitioners’ 1989 return.    Petitioners

sent a check in the amount of $25,000 with the initial

application for extension, but Mr. Hanna stopped payment on the
                                - 4 -

check.    Petitioners had paid only $12,000 through withholding

toward their 1989 tax liability when the request for extension

was filed.    Petitioners’ 1989 return, postmarked October 15,

1990, reported adjusted gross income of $268,689.71 and a total

tax liability of $59,903.15, with petitioners owing $47,903.15.

     After audits of Babb & Hanna’s and petitioners’ Federal

income tax returns, petitioners agreed to assessment and

collection of respondent’s proposed deficiencies in the amounts

of $8,257.40, $16,749.05, and $37,965.82 for 1987, 1988, and

1989, respectively.    These deficiencies arose from petitioners’

mischaracterization of petitioners’ personal expenses that were

paid by Babb & Hanna as business expenses.    The computations of

the additions to tax and penalty that respondent determined are

based on the liabilities assessed by the agreement.

                               OPINION

Section 6651(a)(1)

     Respondent determined that petitioners are liable for the

section 6651(a) addition to tax for 1987, 1988, and 1989.

Section 6651(a)(1) imposes an addition to tax for failure to file

timely a return, unless the taxpayer establishes that the failure

did not result from “willful neglect” and that the failure was

due to “reasonable cause”.    “Willful neglect” has been

interpreted to mean a conscious, intentional failure or reckless

indifference.    United States v. Boyle, 469 U.S. 241, 245-246

(1985).    “Reasonable cause” requires the taxpayers to demonstrate
                               - 5 -

that they exercised ordinary business care and prudence and were

nonetheless unable to file a return within the prescribed time.

Id. at 246; sec. 301.6651-1(c)(1), Proced. & Admin. Regs.     The

addition to tax equals 5 percent of the tax required to be shown

on the return for the first month, with an additional 5 percent

for each additional month or fraction of a month during which the

failure to file continues, not to exceed a maximum of 25 percent.

Sec. 6651(a)(1).   Petitioners bear the burden of proving that

respondent’s determination was incorrect.   Rule 142(a); Cluck v.

Commissioner, 105 T.C. 324, 339 (1995).

     1987

     Petitioners argue that respondent’s failure to retain the

envelope bearing the 1987 return in their file should relieve

them of liability for the section 6651 addition to tax.

Petitioners' argument is not supported by authority or logic.

Petitioners signed the return no earlier than October 15, 1988,

the last date for timely filing of the return.     In their trial

memorandum, they admitted that it was thereafter returned for

insufficient postage and then remailed obviously after the due

date.   Mr. Hanna testified to the same effect.    Respondent's

records are consistent with this explanation.     In these

circumstances, respondent's failure to keep the envelope is not

material.   Cf. Oppenheimer v. Commissioner, 16 T.C. 515 (1951).

Respondent’s determination that petitioners are liable for the

section 6651(a)(1) addition to tax for 1987 will be sustained.
                               - 6 -

     1988

     Mr. Hanna testified that petitioners’ 1988 return was mailed

on or about October 15, 1989, and that it was not until he

requested a copy of petitioners’ 1988 return from the IRS that he

discovered that the 1988 return had not been filed.    This

explanation is implausible.   The 1988 return indicated that

$21,513.99 was owed by petitioners.    Petitioners presumably would

have noticed if a check in this amount had been sent with the

return and had not cleared their account.    If no check was sent,

they would have expected to receive a notice to pay the balance

shown.

     Mr. Hanna claims to have requested another extension to file

petitioners’ 1988 return after discovering that the 1988 return

had not been filed with the IRS.   He testified that this

extension was granted, extending the due date for petitioners’

1988 return until October 15, 1990.    A document was introduced at

trial that purported to be a copy of the approved extension

request that extended the due date of petitioners’ 1988 return

until October 15, 1990.   IRS records regarding the 1988 tax year

to which petitioners stipulated do not indicate that the IRS ever

received this request or that such a request was approved.     In

this case, the maximum extension authorized by law is 6 months.

Sec. 6081(a).

     While we question the validity of the purported 1990

extension, we need not reach that issue.    Petitioners were
                                  - 7 -

initially granted extensions to October 15, 1989, for filing

their 1988 return.    The additional request for extension was not

signed by petitioners until August 15, 1990, 10 months after the

initial extensions had expired.     Even if petitioners’ August 15,

1990, request had been mistakenly approved by the IRS,

petitioners could not have relied on it as permission for the

late filing.    The 10-month period during which they did not have

an outstanding extension justifies the section 6651(a)(1)

addition to tax for 1988.    See sec. 1.6081-4(a)(3), Income Tax

Regs. (application for extension must be filed on or before the

date that the return was required to be filed).

     1989

     Petitioners requested and received an extension to file

their 1989 return.    An extension of time to file does not extend

the time for payment of any tax due, and the form must “be

accompanied by the full remittance of the amount properly

estimated as tax which is unpaid as of the date prescribed for

the filing of the return.”    Sec. 1.6081-4(a)(4), Income Tax Regs.

Respondent may properly void an extension where the application

is invalid because of a failure to estimate properly a tax

liability.     Crocker v. Commissioner, 92 T.C. 899, 905 (1989).   An

underestimation, however, does not make an extension application

per se invalid.     Id. at 906.

     Petitioners did not produce at trial any evidence of how

they calculated their tax liability for 1989 when making their
                                - 8 -

original extension request.    Federal taxes totaling $12,000 had

been withheld from petitioners' income during 1989, but

petitioners did not include any additional payment of taxes with

their initial 1989 extension application.    On their 1989 return,

filed in October 1990, petitioners calculated their adjusted

gross income to be $268,689.71 and their total tax liability to

be $59,903.15.

     Petitioners failed to offer any evidence that would explain

how they computed their tax liability for purposes of the

extension request, on which their tax liability was

underestimated by more than $47,000.    Petitioners argue that

reasonable cause existed for their failure to estimate properly

because their tax records for 1989 were unavailable due to

pending litigation with Mr. Hanna’s former business associate.

Inability to obtain information does not generally constitute

reasonable cause if taxpayers could have filed a timely return

with a reasonable degree of accuracy based on their best

knowledge.    See Estate of Vriniotis v. Commissioner, 79 T.C. 298,

311 (1982); Electric & Neon, Inc. v. Commissioner, 56 T.C. 1324,

1343 (1971), affd. without published opinion 496 F.2d 876 (5th

Cir. 1974).   In this case, Mr. Hanna presented no evidence that

his law practice income or that Mrs. Hanna’s income had decreased

in any amount from prior years, such as 1987 and 1988, when

petitioners' adjusted gross income had been $190,280.08 and

$254,374.46, respectively.    There is also no evidence that
                               - 9 -

petitioners computed their tax based on past income history or

that it was consistent with the computation of tax for any prior

year.

     Respondent appropriately voided petitioners’ 1989 extension

because petitioners failed to estimate properly their tax

liability, as required under Crocker v. Commissioner, supra.

Thus, respondent’s determination that petitioners are liable for

the section 6651(a)(1) addition to tax for 1989 will be

sustained.

Section 6653(a)(1)(A) and (B) and Section 6653(a)(1)

     Respondent determined that petitioners are liable for the

section 6653(a)(1)(A) and (B) addition to tax for 1987 and the

section 6653(a)(1) addition to tax for 1988.   Section

6653(a)(1)(A) and section 6653(a)(1) impose an addition to tax

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

underpayment is due to negligence or intentional disregard of

rules or regulations.   Section 6653(a)(1)(B) imposes an addition

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

the underpayment attributable to negligence.   Negligence is

defined as a lack of due care or failure to do what a reasonable

and ordinarily prudent person would do under the circumstances.

Leuhsler v. Commissioner, 963 F.2d 907, 910 (6th Cir. 1992),

affg. T.C. Memo. 1991-179; Neely v. Commissioner, 85 T.C. 934,

947-948 (1985).   Petitioners bear the burden of proving that
                              - 10 -

respondent’s determinations are erroneous.   Rule 142(a); Bixby v.

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

     Petitioners have produced no evidence that their failure to

file timely in 1987 and 1988 was due to reasonable cause.

Petitioners' failure to file is prima facie evidence of

negligence.   See Emmons v. Commissioner, 92 T.C. 342, 349 (1989),

affd. 898 F.2d 50 (5th Cir. 1990).

     In addition, petitioners understated their income in 1987

and 1988 due to their practice of mischaracterizing as business

expenses, and failing to report as income, their personal

expenses that were paid by Babb & Hanna.   Mr. Hanna testified

that he was aware that personal expenses were being paid by the

corporation but assumed that they would ultimately be charged as

income to him.   He gave no reason for failing to report the

payments as income in the years that they were made.    Such

mischaracterization of expenses is strong evidence of

petitioners’ lack of due care and disregard of the income tax

rules or regulations.   See, e.g., Gutierrez v. Commissioner, T.C.

Memo. 1995-252; Epstein v. Commissioner, T.C. Memo. 1994-34.

     Respondent’s determination that petitioners are liable for

the section 6653(a)(1)(A) and (B) addition to tax for 1987 and

the section 6653(a)(1) addition to tax for 1988 will be

sustained.
                                 - 11 -

Section 6661

     Respondent determined that petitioners are liable for the

section 6661 addition to tax for 1987 and 1988.     Petitioners bear

the burden of proving that respondent’s determination is not

correct.    Rule 142(a); Cluck v. Commissioner, 105 T.C. at 339.

Section 6661(a) provides for an addition to tax on underpayments

attributable to a substantial understatement of income tax.

Section 6661(b)(2)(A) defines the term “understatement” as being

the excess of the amount of tax required to be shown on the

return for the taxable year over the amount shown on the return.

An understatement is substantial if it exceeds the greater of

10 percent of the tax required to be shown on the return or

$5,000.    Sec. 6661(b)(1)(A).   The deficiencies to which

petitioners agreed for 1987 and 1988 represent substantial

understatements in each year.

     The section 6661 addition to tax is not applicable, however,

if there was substantial authority for the taxpayers’ treatment

of the items in issue or if the relevant facts relating to the

tax treatment were adequately disclosed on the return.       Sec.

6661(b)(2)(B)(i) and (ii).    Petitioners did not present any

evidence at trial that would support a claim that there was

substantial authority for their treatment of the items in issue

or that the treatment was adequately disclosed on their returns.

Accordingly, we conclude that petitioners are liable for the

additions to tax under section 6661 for 1987 and 1988.
                               - 12 -

Section 6662(a)

     Respondent determined that petitioners are liable for the

section 6662(a) penalty for 1989.    Section 6662(a) imposes a

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

tax attributable to one or more of the items set forth in section

6662(b).    In the notice of deficiency, respondent based the

determination of the section 6662(a) penalty on petitioners’

underpayment's being due to a substantial understatement.     See

sec. 6662(b)(2).

     The accuracy-related penalty does not apply with respect to

any portion of an underpayment if it is shown that there was

reasonable cause for such portion of an underpayment and that

petitioners acted in good faith with respect to such portion.

Sec. 6664(c)(1).   The determination of whether petitioners acted

with reasonable cause and in good faith depends upon the

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

Tax Regs.

     The underpayment of petitioners' tax for 1989 was

substantial in that it totaled almost $38,000.     Because they

failed to show how the amount paid with their request for

extension was estimated, petitioners also failed to show that

they acted in good faith with respect to the underpayment.      See

sec. 6662(d)(1)(A).    Respondent’s determination that petitioners

are liable for the section 6662(a) penalty for 1989 will be

sustained.
                        - 13 -

To reflect the foregoing,

                                  Decision will be entered

                             for respondent.
