                        T.C. Memo. 2004-263



                      UNITED STATES TAX COURT



          STEVEN J. AND TERRY L. NAMYST, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 20313-03.              Filed November 17, 2004.


     Jay B. Kelly, for petitioners.

     Blaine Holiday, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     GOEKE, Judge:   Respondent determined deficiencies of $2,497,

$3,724, $2,875, and $3,343, in petitioners’ 1996, 1997, 1998, and

1999 Federal income taxes, respectively.   Respondent also

determined penalties under section 66621 of $499.40, $744.80,


     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code as amended, and all Rule references are
                                                   (continued...)
                                 - 2 -

$575, and $669, for 1996, 1997, 1998, and 1999, respectively.

There are four issues for decision.

     First, were amounts Mr. Namyst (petitioner) received from

Intelligent Motion Controls, Inc. (IMC) reimbursements under an

accountable plan qualifying under section 1.62-2(c)(2)(i), Income

Tax Regs., rather than amounts includable in petitioners’ gross

income as compensation?   We hold the amounts received were

includable in petitioners’ gross income as compensation.

     Second, were amounts petitioners received for the sale of

petitioner’s tools includable in their gross income?    We hold

that they were.

     Third, does the 6-year period of limitations under section

6501(e)(1)(A) permit respondent’s determination for 1998?      We

hold that it does.

     Fourth, are petitioners liable for the accuracy-related

penalty under section 6662(a)?    We hold that they are not.

                          FINDINGS OF FACT

     Some of the facts are stipulated.    The stipulation of facts

and the attached exhibits are incorporated herein by this

reference.   At the time the petition was filed, petitioners

resided in Eagan, Minnesota.



     1
      (...continued)
to the Tax Court Rules of Practice and Procedure.
                               - 3 -

     Petitioners, husband and wife, filed joint Federal income

tax returns for 1996, 1997, 1998, and 1999.    Petitioner was

employed by IMC, beginning in 1994 and during the years in issue.

IMC made motor controls for blood pumps, and, later, developed

digital inspection hardware and software for the jewelry

industry.   IMC’s products included a patented device to analyze

and appraise diamonds.   Petitioner was employed to design and

manufacture IMC’s products.

     For each of 1994, 1995, and 1996, petitioner received Forms

W-2, Wage and Tax Statement, from IMC, reporting his wages.

Petitioner’s Form W-2 for 1995 reported $42,000 in gross wages.

Petitioner’s Form W-2 for 1996 reported $7,000 in gross wages.

The amount reported on petitioner’s 1996 Form W-2 represented

wages paid to him between January and March 1996.

     John Kerkinni was the sole shareholder, CEO, and president

of IMC.   He never took a salary from IMC.   Mr. Kerkinni met

petitioner in 1980 when they worked together for another

corporation.   In 1994, Mr. Kerkinni called petitioner and asked

him to come work for IMC to develop the equipment to analyze

diamonds.   Petitioner did not have an ownership interest in IMC.

In designing and manufacturing IMC’s products, petitioner and

other IMC employees used tools and equipment that petitioner had

personally owned for many years (petitioner’s old tools).
                                - 4 -

     In March 1996, Mr. Kerkinni approached petitioner and

informed him that IMC could no longer afford to pay him a salary.

Petitioner claims that at that time, he agreed to continue

working for IMC without a salary.    Petitioner and Mr. Kerkinni

agreed that IMC would reimburse petitioner for any expenses he

paid in performing his duties as an employee.    The reimbursement

payments were to be made whenever and in whatever amounts IMC

could afford to make them.    Mr. Kerkinni also agreed that IMC

would purchase any of petitioner’s old tools that were being used

by employees of IMC.   At Mr. Kerkinni’s request, petitioner kept

an inventory list of the tools and equipment owned by him and

used by IMC employees and added to the list annually.

     During 1996, 1997, 1998, and 1999, petitioner paid expenses

related to his work at IMC.    Petitioner’s expenses included

travel and purchases of new equipment.    IMC issued checks to

petitioner between March and December 1996, and in 1997, 1998,

and 1999.   The amounts of these checks were not reported to

petitioner on a Form W-2, and petitioners did not report the

amounts of the checks on their 1996, 1997, 1998, or 1999 Federal

income tax returns.    The checks from IMC were issued almost every

month, although on different days each month.    The amounts of the

checks varied, from $500 (January 2, 1997) to $4,000 (September

20, 1996), and were generally in round numbers.    Petitioner did

not receive a statement allocating the amounts of the checks
                                - 5 -

between expense reimbursements and payments for IMC’s purchase of

petitioner’s old tools.

     Respondent determined deficiencies for each of petitioners’

taxable years 1996, 1997, 1998, and 1999.   In a notice of

deficiency dated August 28, 2003, respondent adjusted

petitioners’ income for each year to include the amounts of the

checks from IMC.   As a result of respondent’s adjustments to

petitioners’ gross income, petitioners were no longer entitled to

the earned income credits claimed on their returns for 1996,

1997, 1998, and 1999.   The parties stipulated that petitioners

are entitled to the child tax credit for 1998 and 1999.

Respondent also conceded that petitioners were entitled to

miscellaneous itemized deductions, limited under section 67(a) to

the extent the expenses exceeded 2 percent of petitioners’

adjusted gross income, for the expenses petitioner paid on behalf

of IMC in each year.    On brief, respondent conceded an additional

$3,181.82 of petitioners’ expenses for 1996.   The only expenses

listed by petitioner that were not allowed as miscellaneous

itemized deductions by respondent in either the notice of

deficiency or on brief were those made by petitioner before March

1996.   Respondent treated the amounts petitioners received from

IMC in exchange for petitioner’s old tools as wage income.

Respondent also determined that petitioners were liable for an
                              - 6 -

accuracy-related penalty under section 6662(a) for each year in

issue.

                             OPINION

     Petitioners argue that the checks issued to petitioner by

IMC between March 1996 and December 1999 were not wages, but were

in part reimbursements for the expenses petitioner paid in 1994,

1995, 1996, 1997, 1998, and 1999, and in part proceeds from the

sale of petitioner’s tools to IMC.    With respect to the expenses

petitioner paid, petitioners claim that the reimbursement

arrangement between petitioner and Mr. Kerkinni qualifies as an

“accountable plan” under section 1.62-2(c)(2)(i), Income Tax

Regs., and that petitioners were not required to include the

amounts of the expense reimbursements in their gross income.

Petitioners also argue that petitioner sold his old tools to IMC

at reasonable used values set by petitioner totaling $23,919.50,

and that the amounts that represented the proceeds from these

sales were returns of petitioner’s capital and not includable in

gross income.

     Respondent argues that it is unreasonable to believe that

petitioner agreed to work for IMC without a salary or an

ownership interest in the corporation.   Although the arrangement

was unusual, we reject respondent’s contention.   Petitioner is

dedicated to his work and loyal to his friend, Mr. Kerkinni.
                               - 7 -

     The parties do not address the application of section

7491(a) or (c) in the instant case.    Respondent issued the notice

of deficiency on August 28, 2003, and it is possible that

respondent's examination of petitioners’ returns for 1996, 1997,

1998, and 1999 began after July 22, 1998.   However, petitioners

do not argue that the burden of proof shifts to respondent under

section 7491(a) and have not shown that the threshold

requirements of section 7491(a) were met.   We decide the issues

involving petitioners’ unreported income on a preponderance of

the evidence, and the burden of proof does not affect the

outcome.

     We shall first address petitioners’ contention that they

were not required to report as gross income the amounts IMC

reimbursed petitioner for his expenses, which included travel and

the purchases of new equipment on behalf of IMC.   We shall then

address petitioner’s contention that the remainder of the

payments made by IMC were returns of petitioner’s capital with

respect to the sale of his old tools to IMC.

I.   Accountable Plan

     Section 61 includes in gross income all income, from

whatever source derived.   Section 62 defines adjusted gross

income as gross income minus certain deductions.   Section

62(a)(2)(A) allows taxpayers to deduct from gross income amounts

paid by the taxpayer “in connection with the performance by him
                                 - 8 -

of services as an employee, under a reimbursement or other

expense allowance arrangement with his employer.”     Expense

reimbursements under an accountable plan are not reported as

wages on the employee’s Form W-2 and are exempt from withholding

and payment of employment taxes.     Sec. 1.62-2(c)(4), Income Tax

Regs.     In order to qualify as an accountable plan under section

62(a)(2)(A), an arrangement must satisfy the business connection,

substantiation, and return of excess requirements.       Sec. 1.62-

2(c)(1), Income Tax Regs.     The business connection,

substantiation, and return of excess requirements under section

1.62-2(d), (e), and (f), Income Tax Regs., are applied on an

employee-by-employee basis; therefore, the failure of one

employee to substantiate his expenses would not cause

reimbursements to other employees to be treated as made under a

nonaccountable plan.     Sec. 1.62-2(i), Income Tax Regs.

     A.      Business Connection Requirement

     The business connection requirement is satisfied if an

arrangement provides advances, allowances, or reimbursements only

for business expenses that are allowed as deductions under

sections 161 through 198, and that are paid by the employee in

connection with the performance of services as an employee of the

employer.     Sec. 1.62-2(d)(1), Income Tax Regs.; see also Biehl v.

Commissioner, 118 T.C. 467, 482 (2002), affd. 351 F.3d 982 (9th
                                   - 9 -

Cir. 2003).       Respondent admits that petitioner was an employee of

IMC during all of the years in issue.

       In the notice of deficiency and on brief, respondent allowed

deductions under section 162 for the expenses petitioner paid in

connection with the performance of services as an employee of

IMC.    A deduction under section 162(a) requires that the reported

expenses be “directly connected with or pertaining to” the

taxpayer’s trade or business.       Sec. 1.162-1(a), Income Tax Regs.

Petitioner kept track of the expenses he made carefully, even

deducting sales tax from his expense reports when his own

personal purchases were on receipts with purchases he made for

IMC.    Petitioner was dedicated to IMC’s business, and the work he

was doing to develop IMC’s products.         We believe that the

expenses he made and listed on the expense reports were directly

connected to IMC’s business of developing its products.

Therefore, we conclude that the business connection requirement

was met here.

       B.      Substantiation Requirement

       An arrangement meets the substantiation requirement if it

requires that each business expense be substantiated to the payor

within a reasonable period of time.         Sec. 1.62-2(e)(1), Income

Tax Regs.       A reasonable period of time depends on the facts and

circumstances of each arrangement.         Sec. 1.62-2(g)(1), Income Tax

Regs.       For travel, entertainment, and other expenses governed by
                              - 10 -

section 274(d), the substantiation requirement is fulfilled if

the employee provides information sufficient to satisfy the

substantiation requirements of section 274(d) and the regulations

thereunder to the employer.   Sec. 1.62-2(e)(2), Income Tax Regs.

Section 274(d) allows a deduction for expenses of traveling away

from home only if an employee substantiates the amount, date,

time, place, and business purpose for the travel.    Sec. 1.274-

5T(b)(2), Temporary Income Tax Regs., 50 Fed. Reg. 46014 (Nov. 6,

1985).   For business expenses not governed by section 274(d), the

employee must submit information to the employer sufficient to

enable the employer to identify the specific nature of each

expense and conclude that the expense is attributable to the

employer’s business activities.   For these nonsection 274(d)

expenses, each of the elements of an expenditure or use must be

substantiated to the payor.   Sec. 1.62-2(e)(3), Income Tax Regs.

     Petitioner and Mr. Kerkinni testified that petitioner

submitted a list of expenses and receipts to Mr. Kerkinni

annually.   In addition, before making expenditures on behalf of

IMC, petitioner would inform Mr. Kerkinni that his work required

a certain piece of equipment, and, with Mr. Kerkinni’s

permission, he would purchase what was needed.   Petitioner would

then show Mr. Kerkinni the receipts.   Mr. Kerkinni asked

petitioner to keep track of and save the receipts.    Petitioner’s

lists and receipts were submitted at trial.   The lists provided
                              - 11 -

by petitioner stated the date, vendor, description, invoice

number, amount, and mileage (where relevant) for each

expenditure.   Each annual list was attached to an envelope

containing receipts for the expenses.   Some of petitioner’s

expenses were for travel away from home for trade shows, and the

rest were for expenses not covered by section 274(d) (i.e.,

equipment for IMC’s business).

     As described above, respondent allowed petitioners

deductions from adjusted gross income under section 162 for the

1996, 1997, 1998, and 1999 expenses listed in the exhibits

submitted at trial.   These lists of expenses were the lists

petitioner created for substantiation of his expenses to Mr.

Kerkinni.   The substantiation rules for business expense

deductions under sections 162 and 274(d) are incorporated by

section 1.62-2(e)(1) through (3), Income Tax Regs., for the

purpose of determining whether a reimbursement arrangement

constitutes an accountable plan.   In the notice of deficiency and

on brief, respondent accepted petitioner’s lists as proper

substantiation under section 162, and we agree that petitioner

has met the substantiation requirements of section 162.     We

believe that petitioner’s lists of expenses were also

sufficiently detailed to qualify as proper substantiation under

the requirements of section 274(d), where applicable.
                               - 12 -

     In order to meet the substantiation requirement of section

1.62-2(e), Income Tax Regs., petitioner must have actually

submitted his substantiation to IMC in order to be reimbursed.

We have found above that petitioner submitted expense reports to

Mr. Kerkinni annually, and he showed Mr. Kerkinni the receipts

after each expenditure was made.   Petitioner’s records were kept

carefully, and at the end of each year, he submitted an accurate

list of his expenditures.   That petitioner kept Mr. Kerkinni

informed of his expenditures when they were made helps to

convince us that it was reasonable for petitioner to submit a

detailed list only annually.

     C.   Returning Amounts in Excess of Expenses

     Section 1.62-2(f), Income Tax Regs., provides that an

arrangement meets the third requirement of an accountable plan if

the employee is required to return to the payor within a

reasonable period of time any amount paid under the arrangement

in excess of the expenses substantiated.   When an employer

advances money to an employee for anticipated expenses, paragraph

(f) of section 1.62-2, Income Tax Regs., is satisfied only if the

amount of money advanced is reasonably calculated not to exceed

the amount of anticipated expenditures, the advance is made

within a reasonable period of when the expenditures are made, and

any excess of the advance over the substantiated expenses is

required to be repaid within a reasonable period after the
                               - 13 -

advance is received.   The facts and circumstances of each

arrangement determine whether an employee is required to return

amounts in excess of substantiated expenses.    Id.

     Under the arrangement here, petitioner was required to get

Mr. Kerkinni’s permission before making expenditures for IMC.     He

was also required to submit his receipts to Mr. Kerkinni for

reimbursement.    IMC agreed to pay petitioner whatever amounts it

could afford to pay as reimbursements.   There is no evidence that

petitioner was required to return any amounts he received that

exceeded his expenses.   Although petitioner was required to

substantiate expenses, the annual reimbursement amounts exceeded

petitioner’s expenses.   If the excess amounts were meant to be

advances for anticipated expenses petitioner would make, there is

no evidence that the advances were calculated to approximate the

amounts of the anticipated expenditures.   The record does not

show whether petitioner did in fact return any of the excess

amounts to IMC.   Based on all the facts available to us, we do

not believe that the arrangement between petitioner and Mr.

Kerkinni required petitioner to return excess amounts to IMC.

Therefore, the arrangement did not satisfy the returning amounts

in excess of expenses requirement of section 1.62-2(f), Income

Tax Regs.

      We believe that petitioner and Mr. Kerkinni did come to an

agreement about how IMC would reimburse petitioner for his
                              - 14 -

expenses.   However, because petitioners have not shown that the

reimbursement arrangement satisfied all three of the requirements

of section 1.62-2, it did not qualify as an accountable plan

under section 62(a)(2)(A) and section 1.62-2(c), Income Tax Regs.

Therefore, the amounts petitioner received from IMC in the last 9

months of 1996, and in 1997, 1998, and 1999, in excess of the

amounts IMC paid for petitioner’s tools as described below,

should be included in petitioners’ gross income in those years as

compensation.

II.   Expenses Paid in 1994 and 1995

      Petitioners argue that expenditures of $10,393.90 petitioner

made in 1994 and 1995 were properly excludable from their gross

income in the years covered by the accountable plan, because the

amounts were repaid as part of an accountable plan.   IMC paid

petitioner a salary in 1994 and 1995 but did not reimburse him

for expenses during those years.2   Because we have found that the

arrangement between petitioner and Mr. Kerkinni did not qualify

as an accountable plan in 1996, 1997, 1998, or 1999, petitioner’s

expenses in 1994 and 1995 were not part of an accountable plan in

any year.




      2
      The record does not show whether petitioners claimed these
expenses as miscellaneous itemized deductions from their adjusted
gross income in 1994 and 1995.
                                - 15 -

III.   Sale of Petitioner’s Tools to IMC

       Petitioner claims that, as a part of his arrangement with

Mr. Kerkinni in 1996, he agreed to sell his old tools to IMC.

Petitioner used his old tools in his work for IMC, and other

employees of IMC also used the tools.      In 1996, petitioner

brought the tools to IMC and allowed it to take ownership and

possession of them.    At that time, petitioner agreed with Mr.

Kerkinni that he would keep an inventory of the tools that he

transferred to IMC.    Petitioner updated the inventory list

annually as more of his tools were used by IMC employees.        He

also agreed to assign a reasonable used value to each tool, which

values IMC accepted as sale prices.      The record does not show how

petitioner arrived at the values he placed on his tools.

Respondent does not dispute that petitioner sold his tools to IMC

for the amounts petitioner listed in the inventory and that IMC

took possession of the tools.    We are convinced that petitioner

did sell his old tools to IMC.

       Petitioners argue that the entire amount IMC paid for the

tools should be treated as a return of capital.      Respondent

argues that because petitioners did not establish basis in any of

the purchased tools, the amount paid for the tools should be

treated as compensation for services to IMC.      Because we have

concluded that petitioner did sell his tools to IMC, we disagree

with respondent’s characterization of the proceeds from the sale
                              - 16 -

of the old tools as compensation.   It is likely that some of

petitioner’s old tools qualified as capital assets under section

1221 and some of the old tools were property used in petitioner’s

trade or business (of being an employee of IMC) of a character

subject to the allowance for depreciation under section

167(a)(1).3   See Noyce v. Commissioner, 97 T.C. 670, 683 (1991).

It is unnecessary for us to distinguish among petitioner’s old

tools; the result is the same.   Gain from the sale of a capital

asset held longer than 1 year is long-term capital gain under

section 1222(3), and net gain from the sale of property used in a

taxpayer’s trade or business is treated as long-term capital gain

under section 1231(a)(1).   Petitioner has shown that he owned all

of the old tools for more than 1 year before he first began

selling them to IMC; i.e., March 1996.   We believe, based on

petitioner’s testimony and the photographs the parties submitted

of petitioner’s old tools, that these were tools petitioner owned

for both everyday use and use in his work for many years.4


     3
      We do not believe that any of the tools petitioner sold to
IMC during 1999 should be characterized as supplies of a type
regularly used or consumed by petitioner in the ordinary course
of his trade or business within the meaning of sec. 1221(a)(8).
Any such supplies held or acquired by a taxpayer on or after Dec.
17, 1999, are excluded from characterization as capital assets by
sec. 1221(a)(8).
     4
      We make the distinction between long- and short-term
capital gain with respect to petitioner’s old tools only. IMC
reimbursed petitioner for the new equipment he purchased for IMC
during 1994, 1995, 1996, 1997, 1998, and 1999 as part of the
                                                   (continued...)
                                  - 17 -

       A taxpayer must establish his cost or adjusted basis for the

purpose of determining gain or loss that he must recognize on a

sale of property.       O’Neill v. Commissioner, 271 F.2d 44, 50 (9th

Cir. 1959), affg. T.C. Memo. 1957-193; Brodsky v. Commissioner,

T.C. Memo. 2001-240; Schaeffer v. Commissioner, T.C. Memo. 1994-

206.       Proof of the cost or adjusted basis is necessary because

recovery of an amount in excess of cost constitutes income.

Cullins v. Commissioner, 24 T.C. 322, 328 (1955).       In certain

circumstances, we may use the Cohan rule to estimate a taxpayer’s

basis in an asset at the time of transfer.       Cohan v.

Commissioner, 39 F.2d 540 (2d Cir. 1930); Group Admin. Premium

Servs., Inc. v. Commissioner, T.C. Memo. 1996-451.       In order for

the Court to estimate basis, the taxpayer must provide some

“reasonable evidentiary basis” for the estimation.          Group Admin.

Premium Servs., Inc., supra (citing Polyak v. Commissioner, 94

T.C. 337, 345 (1990) and Vanicek v. Commissioner, 85 T.C. 731,

743 (1985)); Saykally v. Commissioner, T.C. Memo. 2003-152.

       Here, petitioners have not provided any facts or details

that permit a reasonable estimate of their basis in the purchased

tools.       Petitioner testified that the tools were his “older

equipment” and that he had owned some of them since he was 10 or

12.    Pictures of each tool were submitted at trial with



       4
      (...continued)
arrangement between petitioner and Mr. Kerkinni.
                              - 18 -

petitioner’s list of the tools’ reasonable used values.      The

pictures, however, were taken on January 1, 2004, in preparation

for trial, and they do not provide evidence of petitioner’s cost

when the tools were new.   The Cohan rule should not be used as a

substitute for petitioners’ burden of proof.    Reinke v.

Commissioner, 46 F.3d 760, 764 (8th Cir. 1995) (citing Coloman v.

Commissioner, 540 F.2d 427, 431-432 (9th Cir. 1976), affg. T.C.

Memo. 1974-78)), affg. T.C. Memo. 1993-197.    Because petitioners

have not provided any information that would help us estimate

their basis in the tools, the Cohan rule is inapplicable.

Consequently, the amount paid by IMC for petitioner’s tools

should be treated as long-term capital gain by petitioners, and

it is includable in petitioners’ gross income for the years in

which the amounts were received.   Based on the inventory list and

petitioner’s credible testimony, it appears that petitioner

transferred ownership of most of his tools in 1996.   As a result,

we shall allocate $19,371.25 (the total amount IMC paid

petitioner in 1996) to 1996 for the sale of the tools.      The

inventory list that petitioner created at the beginning of 1997

indicates that he sold $23,140.50 worth of old tools to IMC in

1996.   However, petitioner was paid only $19,371.25 in 1996.      We

believe IMC purchased $3,769.25 (the difference between

$23,140.50 and $19,371.25) worth of tools in 1997.    The inventory

list petitioner created in early 1998 indicates that petitioner
                                - 19 -

also sold $245 worth of tools in 1997. Therefore, in total, we

allocate $4,014.25 for the sale of tools to petitioners’ 1997 tax

year.     Petitioner’s inventory list indicates that petitioner

transferred $320 worth of tools in 1998; therefore, $320

attributable to the sale of the tools will be allocated to

petitioners’ 1998 gross income.      Petitioner sold $214 worth of

tools in 1999; therefore, $214 attributable to the sale of the

tools will be allocated to petitioners’ 1999 gross income.

IV.   Summary of Unreported Income

        In summary, petitioners improperly failed to report the

following amounts in their income:

        Year           Sale of tools        Compensation

        1996           $19,371.25                -0-
        1997             4,014.25            $15,635.75
        1998               320.00             21,280.00
        1999               214.00             29,286.00

V.    Period of Limitations for 1998

        Generally, the Commissioner must assess an income tax

deficiency for a specified year within 3 years from the date the

taxpayer's return for that year was filed.      Sec. 6501(a).

However, in cases where a filed return omits from gross income an

amount exceeding 25 percent of the amount stated as gross income

on the return, section 6501(e) provides that the tax may be

assessed at any time within 6 years of the filing of the return.

Petitioners argue that the 3-year period of limitations on
                                 - 20 -

assessment under section 6501(a) applies for their 1998 tax year,

and that the period expired before respondent issued the notice

of deficiency on August 28, 2003.5        Respondent admits that

petitioners filed their 1998 return on April 15, 1999.        However,

respondent argues that because petitioners underreported their

income by more than 25 percent of the amount of gross income

stated on their return, the appropriate period of limitations is

6 years, pursuant to section 6501(e).        Because we concluded above

that petitioners are not entitled to exclude their income from

IMC in any year as paid under an accountable plan, petitioners

underreported their gross income for 1998 by $21,600.

Petitioners reported gross income of $18,562 on their 1998

return.    Twenty-five percent of $18,562 is $4,640.50.      Therefore,

the appropriate period of limitations is 6 years under section

6501(e).    The period of limitations for assessment of

petitioners’ 1998 taxes did not expire before respondent issued

the notice of deficiency.

VI.   Accuracy-Related Penalty

      Respondent asserted an accuracy-related penalty under

section 6662(a) for each of petitioners’ taxable years 1996,

1997, 1998, and 1999.    Section 6662(a) provides that if section

6662 applies to any “portion of an underpayment of tax required


      5
      Petitioners signed Form 872, Consent to Extend the Time to
Assess Tax, for their taxable years 1996, 1997, and 1999.
                               - 21 -

to be shown on a return, there shall be added to the tax an

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

which [section 6662] applies.”   As relevant here, section 6662

applies to the portion of any underpayment that is attributable

to negligence or disregard of the rules or regulations.     Sec.

6662(b)(1).   The term “negligence” includes any failure to make a

reasonable attempt to comply with the provisions of the internal

revenue laws or to exercise ordinary and reasonable care in the

preparation of a tax return.   Sec. 6662(c); Gowni v.

Commissioner, T.C. Memo. 2004-154.      The term “disregard” includes

any careless, reckless, or intentional disregard.     Sec. 6662(c).

Under section 6664, an exception is provided to the imposition of

a section 6662 accuracy-related penalty where a taxpayer

establishes that there was reasonable cause for the

understatement and that the taxpayer acted in good faith.     Sec.

6664(c)(1).   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 proper tax liability.     Sec.

1.6664-4(b)(1), Income Tax Regs.

     We have concluded that petitioners were required to report

as gross income the amounts received as reimbursements of

petitioner’s substantiated expenses and in exchange for
                              - 22 -

petitioner’s tools.   Our resolution of the issues in this case

required careful examination of the relevant laws, trial

exhibits, and testimony.   Petitioners’ omission of the

reimbursement income from IMC was made in good faith and with the

belief that the reimbursement arrangement would qualify as an

accountable plan.   It was not unreasonable that petitioners did

not report any of the income, since the arrangement between

petitioner and Mr. Kerkinni provided that petitioner would not

receive any reportable wages from IMC, and petitioner did not

receive a Form W-2 for any of the years in issue.     In addition,

petitioners’ failure to report the proceeds they received for

petitioner’s tools was a result of their belief that the payments

did not exceed petitioner’s basis in the tools.    Based on the

information they had, petitioners made an effort to comply with

the tax laws in preparing their returns.    Therefore, we conclude

that the accuracy-related penalty is not appropriate, and

petitioners are not liable for the penalty pursuant to section

6662.

     To reflect the foregoing and concessions by respondent,


                                           Decision will be entered

                                    under Rule 155.
