                         T.C. Memo. 2008-171



                       UNITED STATES TAX COURT



         LARRY J. AND SHERILYN WADSWORTH, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 10823-05.              Filed July 21, 2008.



     Lillian W. Wyshak, for petitioners.

     Valerie L. Makarewicz, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


     KROUPA, Judge:    Respondent determined a $147,708 deficiency

for 2001 and a $56,958 deficiency for 2002 in petitioners’

Federal income tax based on petitioners’ amended returns for

those years.   Respondent also determined accuracy-related
                                  -2-

penalties under section 6662(a)1 of $29,541.60 for 2001 and

$11,125.60 for 2002.

     After concessions,2 the only remaining issue is whether

petitioners are liable for the accuracy-related penalties for

2001 and 2002.3   We hold that petitioners are liable for the

accuracy-related penalties.

                         FINDINGS OF FACT4

     Some of the facts have been stipulated and are so found.

The stipulation of facts and the accompanying exhibits are

incorporated by this reference.    Petitioners resided in

California at the time they filed the petition.



     1
      All section references are to the Internal Revenue Code in
effect for the years at issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure, unless otherwise
indicated.
     2
      This Court issued an order denying petitioners’ amended
motion to dismiss for lack of jurisdiction, amended motion to
strike, and motion to shift the burden of proof, pursuant to
Wadsworth v. Commissioner, T.C. Memo. 2007-46. Petitioners renew
their objection to our jurisdiction. We reject their position,
for the reasons stated in Wadsworth v. Commissioner, supra.
     3
      Petitioners conceded at trial and on brief that the amounts
of income tax they originally reported on the returns for 2001
and 2002 were accurate and that the amended returns were
inaccurate. Petitioners nevertheless maintain that the
deficiencies are still at issue. We find petitioners’ position
inexplicable and completely at odds with their concession and
actions.
     4
      Petitioners’ briefs failed to comply with Rule 151(e).
They failed to include a statement of the nature of the
controversy, the tax involved, and the issues to be decided.
They also failed to include proposed findings of fact and a
concise statement of the points upon which they rely.
                                -3-

     Larry Wadsworth (petitioner) was a general partner of Gold

Coast Medical Services (GCMS), a partnership with gross receipts

exceeding a million dollars, in 2001 and 2002.   GCMS operated a

pharmacy that provided medical products and services to eligible

beneficiaries of the California Medical Assistance Program during

2001 and 2002.

     Petitioners timely filed Federal income tax returns for 2001

and 2002 and attached a Schedule E, Supplemental Income and Loss,

to each return.   Petitioners reported $534,424 of total income on

the Schedule E for 2001 and $345,546 of total income on the

Schedule E for 2002, both amounts consisting solely of non-

passive income from GCMS.   GCMS also timely filed Forms 1065,

U.S. Return of Partnership Income, for 2001 and 2002.5

DHS Audit

     The California Department of Health Services (DHS) audited

GCMS’s books after petitioners’ original returns were filed.     DHS

issued its audit report on August 19, 2003, for the period from

January 1, 2001, through February 28, 2002.   DHS concluded that

GCMS had been overpaid for those periods and directed GCMS to

remit $2,311,634.39 within 60 days of the issuance of the audit

report or be subject to interest and an offset of 100 percent

withholding on current billings.



     5
      The returns filed by GCMS are not at issue except to the
extent that petitioner reported his distributive share of the
partnership’s income and loss. Sec. 702.
                                 -4-

Amended Returns

     Keith Borges prepared the original GCMS partnership returns

for 2001 and 2002 and the original Federal income tax returns for

2001 and 2002 that petitioners filed.    He had prepared returns

for petitioners since 1994.   Mr. Borges received a bachelor of

science degree with an emphasis in accounting in 1979 and has

been an accountant ever since.   He has been a certified public

accountant since 1981 and is a partner in the accounting firm of

Anderson Lucas Somerville & Borges.    He is a member of the

American Institute of Certified Public Accountants and the

California Society of Certified Public Accountants.

     Petitioner and Robert Rosenstein, the attorney representing

GCMS in its appeal of the DHS audit findings, contacted Mr.

Borges after the audit and asked if the partnership tax returns

could be amended to claim a deduction for the amount reflected in

the DHS audit as a contingent liability.    Mr. Borges researched

whether the deduction was appropriate, decided that it was not,

and then declined to amend the returns.    He requested that Mr.

Rosenstein send him any supporting information or legal authority

to justify claiming a deduction for a contingent liability.    Mr.

Borges never received any additional information.

     Petitioners and Mr. Rosenstein next looked to Douglas Huff

to amend the returns and claim the deduction.    Mr. Huff had a

background in finance and had been preparing returns for Mr.
                                  -5-

Rosenstein’s clients for some time.     He amended the GCMS returns

after discussions with Mr. Rosenstein but without consulting tax

cases or any other information.    Mr. Huff had several

conversations with Mr. Rosenstein about the amended returns

because Mr. Borges’ refusal to amend the returns concerned Mr.

Huff, yet he went ahead with amending the returns.     Mr. Huff

described Mr. Rosenstein as a “bankruptcy-tax attorney” who had

been preparing returns for many years.     Mr. Huff amended

petitioners’ returns based on what he described as a “possible

contingent liability.”

     GCMS filed amended partnership returns after DHS issued its

audit report but before learning the result of GCMS’s appeal.

The amended partnership returns reported that GCMS reduced its

gross receipts for “returns and allowances” by $1,981,401 for

2001 and by $330,555 for 2002 to correspond to the amounts

identified in the DHS audit report.

     Petitioners filed amended individual returns in March 2004

reflecting the changes in GCMS’s partnership income.      Petitioners

attached an amended GCMS Schedule K-1, Partner’s Share of Income,

Credits, Deductions, etc., to each amended return and reported a

decrease in partnership income and a loss from the partnership

activity on each return.   The changes reflected the amounts

identified in the DHS audit report.     Those changes resulted in
                                 -6-

petitioners’ claiming and receiving a $147,708 refund for 2001

and a $56,958 refund for 2002.

Appeal of DHS Audit Findings

       GCMS appealed the DHS audit findings.    After GCMS amended

its returns to pass through to petitioner the “possible

contingent liabilities” arising from that audit, the results of

the DHS audit were overturned.    The DHS Office of Administrative

Hearings and Appeals concluded on September 7, 2004, that GCMS

did not engage in discriminatory billing and had not been

overpaid.    Consequently, GCMS made no reimbursement payments to

DHS.

       Petitioners’ amended returns prompted respondent’s

examination of petitioners’ returns.      Respondent examined

petitioners’ returns for each of the years at issue and

determined deficiencies in the amounts allowed as refunds of the

overpayments claimed on the amended returns.      Petitioners timely

filed the petition.

                               OPINION

       Petitioners have paid and conceded the deficiencies

resulting from the amended returns.      The issue remaining is

whether petitioners are liable for the accuracy-related penalties

with respect to the deficiencies attributable to claiming the

contingent liabilities.
                                -7-

Accuracy-Related Penalty

     Respondent determined that petitioners are liable for

accuracy-related penalties for substantial understatements of

income tax under section 6662(b)(2) for 2001 and 2002.6   A

taxpayer is liable for an accuracy-related penalty of 20 percent

for any part of an underpayment attributable to, among other

things, a substantial understatement of income tax.    See sec.

6662(a) and (b)(2); sec. 1.6662-2(a)(2), Income Tax Regs.     There

is a substantial understatement of income tax if the amount of

the understatement exceeds the greater of either 10 percent of

the tax required to be shown on the return, or $5,000.    Sec.

6662(d)(1)(A); sec. 1.6662-4(b)(1), Income Tax Regs.

     Respondent has the burden of production under section

7491(c) and must come forward with sufficient evidence that it is

appropriate to impose the penalty.    See Higbee v. Commissioner,

116 T.C. 438, 446-447 (2001).   Petitioners reported $23,986 of

tax due for 2001 when $171,694 was required.   Petitioners

reported $38,265 of tax due for 2002 when $95,233 was required.

These understatements exceed the section 6662 threshold



     6
      Respondent determined in the alternative that petitioners
were liable for accuracy-related penalties for negligence or
disregard of rules or regulations under sec. 6662(b)(1) for the
years at issue. Because respondent has proven that petitioners
substantially understated their income tax for the years at
issue, we need not consider whether petitioners were negligent or
disregarded rules or regulations.
                                 -8-

for both years.    We find respondent has satisfied his burden of

production.

Disclosure of a Position and Reasonable Basis for Treatment

       No accuracy-related penalty may be imposed for a substantial

understatement of income tax, however, when the taxpayer

adequately discloses the relevant facts affecting the tax

treatment of an item and there existed a reasonable basis for the

treatment of that item.    Sec. 6662(d)(2)(B); sec. 1.6662-4(e),

Income Tax Regs.    A taxpayer may disclose on a Form 8275,

Disclosure Statement, a Form 8275-R, Regulation Disclosure

Statement, or on the return itself.      Sec. 1.6662-4(f)(1) and (2),

Income Tax Regs.    The Commissioner has prescribed other

circumstances in which information provided on a return is

adequate.    Sec. 1.6662-4(e)(1) and (f)(2), Income Tax Regs.    A

Schedule K-1 is not listed as a proper form for disclosure.      Rev.

Proc. 2001-52, 2001-2 C.B. 491; Rev. Proc. 2002-66, 2002-2 C.B.

724.

       Petitioners argue that attaching the amended Schedule K-1 to

the amended returns was sufficient to alert respondent of

petitioners’ position.    We disagree.   Petitioners failed to

attach a Form 8275 or explain the basis of their changes when

they amended the returns.

       Disclosure will not have an effect, moreover, where the

position on the return has no reasonable basis.     Sec. 1.6662-
                                  -9-

4(e)(2)(i), Income Tax Regs.   The reasonable basis standard is

not satisfied by a return position that is merely arguable.

Secs. 1.6662-4(e)(2)(i), 1.6662-3(b)(3), Income Tax Regs.

     Petitioners essentially argue that they elected the

“modified cash” method of accounting, yet fail to explain what

that is or how it absolves them from the penalty.     The

partnership, if on the cash method of accounting, would have been

entitled to a deduction for a liability to the State of

California for the year in which the liability was paid.      See

sec. 1.461-1, Income Tax Regs.    Petitioners presented no evidence

that the partnership paid any portion of the $2,311,634.39 during

2001 or 2002 to the State of California.     Nor was the partnership

entitled to a deduction for “returns and allowances” in 2001 or

2002 under the accrual method of accounting.     An accrual basis

taxpayer generally cannot accrue a deduction for a contested

liability unless conditions of section 461(f) are met.      The

partnership contested DHS’s report and made no transfer within

the meaning of section 461(f) to provide for the satisfaction of

the liability.   An accrual method taxpayer who fails to satisfy

the conditions of section 461(f) ordinarily is not entitled to

claim a deduction for a contested liability before the year in

which the contest is eliminated by compromise or settlement or

through a final disposition.     Dixie Pine Prods. Co. v.

Commissioner, 320 U.S. 516 (1944).      We find that petitioners had
                                -10-

no reasonable basis for their position, and accordingly the

adequate disclosure exception does not apply.

Petitioners’ Receipt of Refunds Produced Deficiencies

     Petitioners also argue that because the amount of income tax

they originally reported was correct, they are not liable for

penalties.    Again, we disagree.   The crucial question is whether

the refunds of the overpayments claimed on their amended returns

were rebate refunds, subject to recovery by the deficiency

procedures.    If the refunds were made on the ground that the

income tax imposed for each year was less than the amount shown

as tax on petitioners’ return for that year, then the refunds

constitute rebates.    See sec. 6211(b)(2); see also Clayton v.

Commissioner, T.C. Memo. 1997-327, affd. without published

opinion 181 F.3d 79 (1st Cir. 1998).    If the refunds were

unrelated to a recalculation of their tax liabilities, however,

then they would be characterized as non-rebate refunds.       Clark v.

United States, 63 F.3d 83, 86-87 (1st Cir. 1995); O'Bryant v.

United States, 49 F.3d 340, 342 (7th Cir. 1995).     The refunds

here are rebates within the meaning of sections 6211(b)(2) and

6664(a) because they were made on the ground that petitioners’

tax liabilities were less than the amounts shown as tax on their

original returns.    Accordingly, the refunds are subject to the

deficiency regime of sections 6211 through 6216 and result in
                               -11-

underpayments, within the meaning of section 6664(a), on which

the accuracy-related penalties may be imposed.

Petitioners Did Not Have Reasonable Cause or Act in Good Faith

      The accuracy-related penalty is not imposed with respect to

any portion of an underpayment if a taxpayer shows that there was

reasonable cause for, and that the taxpayer acted in good faith

with respect to, that portion of the underpayment.   Sec.

6664(c)(1); sec. 1.6664-4(a), Income Tax Regs.   Petitioners have

the burden of proving that the accuracy-related penalty does not

apply.   See Higbee v. Commissioner, 116 T.C. at 446.   The

determination of whether a taxpayer acted with reasonable cause

and in good faith depends on the pertinent facts and

circumstances, including the taxpayer’s efforts to assess his or

her proper tax liability, the knowledge and experience of the

taxpayer, and the taxpayer’s reliance on the advice of a

professional.   Sec. 1.6664-4(b)(1), Income Tax Regs.   Reliance on

the advice of a professional tax adviser constitutes reasonable

cause and good faith if, under all the circumstances, such

reliance was reasonable and the taxpayer acted in good faith.

Id.   To prove reasonable cause due to reliance on the advice of a

tax adviser, however, the taxpayer must show that the adviser was

a competent professional with sufficient expertise to justify

reliance.   Neonatology Associates, P.A. v. Commissioner, 115 T.C.
                               -12-

43, 99 (2000), affd. 299 F.3d 221 (3d Cir. 2002); Ellwest Stereo

Theatres v. Commissioner, T.C. Memo. 1995-610.

     We agree with respondent that petitioners lacked reasonable

cause for, and failed to act in good faith with respect to, their

substantial understatements of income tax for 2001 and 2002.

Petitioners made very little effort to assess their proper tax

liability, and they failed to heed the advice of their longtime

return preparer, Mr. Borges.   Petitioners ignored Mr. Borges’

advice, and Mr. Huff amended the returns instead.    We find that

Mr. Borges’ refusal to amend the returns should have raised a red

flag for petitioners, but petitioners disregarded that warning.

     Petitioners offer no explanation for their reliance upon Mr.

Rosenstein and Mr. Huff in spite of their longtime preparer Mr.

Borges’ refusal to amend their returns.   Petitioners also failed

to establish that Mr. Huff and Mr. Rosenstein were competent

professionals with sufficient expertise to justify their

reliance.   Mr. Rosenstein never testified.   Mr. Huff did.   Mr.

Huff does not appear to have a background in tax, and he offered

no legal authority to explain why he amended the returns other

than that Mr. Rosenstein directed him to do so.

     Petitioner is a successful businessman who, as a partner of

GCMS, operated a multimillion-dollar business.    It is reasonable

to assume that such a person would investigate the basis for

amending his returns when his longtime accountant advised against
                                 -13-

the position taken in those returns.      Petitioners’ decision to

amend their returns appears to have been motivated not by the

demands of the law but by their desire for tax refunds.

Conclusion

     We find that petitioners’ efforts to assess their correct

tax liabilities were unreasonable and not in good faith.

Petitioners could not in good faith rely upon Mr. Huff’s and Mr.

Rosenstein’s advice when they disregarded their longtime

preparer’s concerns and then provided no explanation of their

decision to follow controversial advice other than that they

wanted the refunds.

     We have considered all the remaining arguments that the

parties made and, to the extent not addressed, we find them to be

irrelevant, moot, or without merit.      Accordingly, we sustain

respondent’s determinations for each of the years at issue

regarding the accuracy-related penalty under section 6662.

     To reflect the foregoing,


                                        Decision will be entered for

                                 respondent.
