                             T.C. Memo. 1997-416



                        UNITED STATES TAX COURT



         NICHOLAS A. AND MARJORIE E. PALEVEDA, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 840-96.                       Filed September 18, 1997.




     Nicholas A. Paleveda, for petitioners.

     Clinton M. Fried, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION

     WELLS, Judge:    Respondent determined deficiencies in

petitioners' Federal income tax and additions to tax and

accuracy-related penalties for the taxable years 1990 and 1991 as

follows:

                                       Additions        Accuracy-Related
                                        to Tax             Penalties
  Year           Deficiency          Sec. 6651(a)(1)      Sec. 6662(a)

  1990             $45,861               $11,465            $9,172
  1991              47,688                11,922             9,538
                                    - 2 -

In the amended answer, respondent asserts revised deficiencies in

petitioners' Federal income tax and additions to tax and

accuracy-related penalties for the taxable years 1990 and 1991 as

follows:

                                        Additions       Accuracy-Related
                                         to Tax            Penalties
    Year         Deficiency          Sec. 6651(a)(1)      Sec. 6662(a)

    1990          $92,568                   $23,142        $18,514
    1991           34,433                     8,609          6,887

      Unless otherwise indicated, all section and Code references

are to the Internal Revenue Code in effect for the years in

issue, and all Rule references are to the Tax Court Rules of

ractice and Procedure.        After concessions,1 the issues to be

decided are as follows:2

      1.   Whether petitioners have substantiated their claimed

deductions on Schedule C for certain business expenses;

      2.   whether petitioners are entitled to certain passive

losses;


1
     Petitioners conceded certain adjustments relating to
unreported interest income, an IRA distribution and a penalty
thereon, a self-employment health insurance deduction, and a
self-employment tax deduction. Additionally, at trial,
petitioners conceded the sec. 6651(a)(1) additions to tax. We
therefore do not consider those additions.
     Respondent conceded that petitioners are entitled to
additional itemized deductions for real estate taxes in the
amount of $7,732, an interest expense in the amount of $15,968,
and charitable contributions in the amount of $7,715.
2
     In their petition, petitioners disputed respondent's
disallowance of a Schedule A deduction for real estate taxes to
the extent of $6,106 for petitioners' 1990 taxable year.
Petitioners, however, make no argument on brief concerning that
issue. Consequently, we consider it to have been conceded.
Rybak v. Commissioner, 91 T.C. 524, 566 (1988).
                                 - 3 -

      3.   whether petitioners have substantiated their claimed

deductions on Schedule A for certain itemized expenses;

      4.   whether petitioners have failed to report income in the

amount of $159,282 for taxable year 1990 and whether petitioners

overreported income in the amount of $41,512 for taxable year

1991;

      5.   whether petitioners are entitled to a business bad debt

deduction for taxable year 1990 for the worthlessness of a loan;

and

      6.   whether petitioners are liable for accuracy-related

penalties pursuant to section 6662(a) for the taxable years in

issue.

                           FINDINGS OF FACT

      Some of the facts have been stipulated for trial pursuant to

Rule 91.     The parties' stipulations of fact are incorporated

herein by reference and are found as facts in the instant case.

      At the time they filed their petition in the instant case,

petitioners resided in Atlanta, Georgia.      Petitioners are husband

and wife.3

      During the years in issue, petitioner Nicholas A. Paleveda

(petitioner) was an employee of Mutual Benefit Life Insurance Co.

(MBL).     Petitioner received from MBL a Form W-2 for 1990 showing

wage income in the amount of $468,218.34 with Social Security tax


3
     Petitioner Marjorie E. Paleveda signed the Federal income
tax returns for the taxable years in issue as Marjorie Ewing.
                                - 4 -

withheld in the amount of $3,924.45.    MBL has no record of

receiving from petitioner any communication disputing the

accuracy of the 1990 Form W-2 or assigning petitioner's wage

income.   Petitioner is being sued by MBL for commission

chargebacks relating to petitioner's 1990 and 1991 wage income.

     On May 29, 1986, Ben D. Razon (assignor) and the law firm of

Hampton, Paleveda, Murphy, Cody & Levy (assignee or firm)

executed an Agreement for Assignment of Partnership Interest

(agreement) in Med-Center, a Florida partnership, in

consideration of the firm's payment of $30,000.    Petitioner

executed the agreement on behalf of the firm.    Additionally,

petitioner wrote a check, dated June 2, 1986, from an account in

his name to Mr. Razon in the amount of $30,000.    In the memo

section of the check was the notation "Partnership Interest".    As

to the firm's purchase of the partnership interest in Med-Center,

no note was ever executed and no loan amortization schedule was

ever issued.

     The preamble to the agreement stated that the firm "desires

to take an assignment of a partial interest in the partnership

share owned by BEN D. RAZON".   Additionally, the agreement

provided in relevant part:

     1.   BEN D. RAZON * * * for and in consideration of the
     payment of $30,000.00, receipt of which is hereby
     acknowledged and the assuming by HAMPTON, PALEVEDA,
     MURPHY, CODY & LEVY of its proportionate share of the
     Partnership liabilities of the above referenced
     Partnership * * * does hereby irrevocably assign,
     transfer and set over to the Assignee a proportionate
                               - 5 -

     share of his right, title and interest in the above
     referenced Partnership.

          *          *         *         *         *           *

     3.   Each of the parties hereto agrees to execute any
     and all documents necessary or appropriate to transfer
     their interests hereby conveyed or to be conveyed to
     the Partnership interest in the property owned by the
     Partnership or the Lease Agreement as it pertains to
     the property if necessary.

     Petitioners filed their Federal income tax returns (returns)

for taxable year 1990 on or about May 20, 1992, and for taxable

year 1991 on or about June 3, 1994.

     Petitioners claimed Schedule C business expenses in the

amounts of $188,104 for taxable year 1990 and $171,182 for

taxable year 1991.   Respondent disallowed business expenses to

the extent of $118,371 for taxable year 1990 and $144,187 for

taxable year 1991.

     Petitioners claimed Schedule E losses in the amount of

$17,751 for taxable year 1990 and $12,686 for taxable year 1991.

Respondent disallowed losses to the extent of $15,966 for taxable

year 1990 and $12,686 for taxable year 1991.

     On their return for taxable year 1991, petitioners claimed

Schedule A itemized deductions in the amount of $56,927.

Respondent disallowed deductions to the extent of $9,244.

Respondent has conceded that, before statutory limitations,

petitioners are entitled to additional deductions for real estate

taxes in the amount of $7,732, charitable contributions in the

amount of $7,715, and interest expense in the amount of $15,968.
                               - 6 -

     In the amended answer, respondent asserts that petitioners

underreported their gross income to the extent of $159,282 for

taxable year 1990 and overreported their gross income to the

extent of $41,512 for taxable year 1991.   Additionally, during

the audit, petitioners claimed a bad debt deduction in the amount

of $30,000 that was not reflected on their Federal income tax

returns or the notice of deficiency.

     Respondent determined that, on the basis of all of the

adjustments in the notice of deficiency, petitioners were liable

for additions to tax and penalties pursuant to sections

6651(a)(1) and 6662(a).   In the amended answer, to reflect the

adjustments related to petitioners' underreporting and

overreporting of income, respondent increased the addition to tax

and penalty for 1990 and decreased the addition to tax and

penalty for 1991.

                              OPINION

     The first issue to be decided is whether petitioners have

substantiated their claimed Schedule C business expenses that

respondent disallowed to the extent of $118,371 for taxable year

1990 and $144,187 for taxable year 1991.   Petitioners argue that

they are entitled to the deductions, citing Cohan v.

Commissioner, 39 F.2d 540, 543-544 (2d Cir. 1930) (under certain

circumstances, when taxpayers establish that they incurred a

trade or business expense but do not substantiate the amount of

the expense, the Court may estimate the amount of the deductible
                               - 7 -

expense).   Petitioners argue that their business expenses are

established by the more than 1,000 canceled checks presented by

petitioner at the audit level and by the fact that the deductions

in issue were allowed by respondent in the 30-day letter.

     Deductions are a matter of legislative grace, and

petitioners bear the burden of proving that they are entitled to

the deductions claimed except as to increased deficiencies.     Rule

142(a); INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992);

New Colonial Ice Co. v. Helvering, 292 U.S. 435 (1934).

Taxpayers must keep sufficient records to establish the amount of

their deductions.   See sec. 6001; Meneguzzo v. Commissioner, 43

T.C. 824, 831-832 (1965); sec. 1.6001-1(a), Income Tax Regs.

Moreover, a taxpayer who claims a deduction bears the burden of

substantiating the amount and purpose of the item claimed.

Hradesky v. Commissioner, 65 T.C. 87, 90 (1975), affd. per curiam

540 F.2d 821 (5th Cir. 1976); sec. 1.6001-1(a), Income Tax Regs.

     In the instant case, petitioners provided no books, records,

or checks substantiating the disallowed business expenses.    As to

the checks petitioner claims to have presented at the audit

level, we decide petitioners' tax liability on the evidence

produced at trial and not a previous record developed at the

administrative level.   Greenberg's Express, Inc. v. Commissioner,

62 T.C. 324, 328 (1974), and case cited therein.   Accordingly, on

the basis of the record in the instant case, we conclude that

petitioners have not carried their burden of substantiating the
                                - 8 -

amount and purpose of the disallowed business expenses.     As

petitioners have failed to establish at trial that they incurred

any Schedule C trade or business deductions beyond those allowed

by respondent, Cohan v. Commissioner, supra, is not applicable in

the instant case.    Accordingly, we sustain respondent's

disallowance of those deductions.

     The next issue to be decided is whether petitioners are

entitled to certain passive losses that respondent disallowed to

the extent of $15,966 for taxable year 1990 and $12,686 for

taxable year 1991.    In the exhibits accompanying the notice of

deficiency, respondent listed petitioners' passive losses for the

taxable years in issue under the heading "PART I - RENTAL REAL

ESTATE WITH ACTIVE PARTICIPATION" and computed the extent to

which petitioners were entitled to the $25,000 offset pursuant to

section 469(i).4    During each of the taxable years in issue,


4
     Sec. 469(i)(1) provides:

          (1) In general.--In the case of any natural
     person, subsection (a) shall not apply to that portion
     of the passive activity loss or the deduction
     equivalent (within the meaning of subsection (j)(5)) of
     the passive activity credit for any taxable year which
     is attributable to all rental real estate activities
     with respect to which such individual actively
     participated in such taxable year (and if any portion
     of such loss or credit arose in another taxable year,
     in such other taxable year).

     Sec. 469(i)(2) provides:

          (2) Dollar limitation.--The aggregate amount to
     which paragraph (1) applies for any taxable year shall
                                                   (continued...)
                                 - 9 -

however, petitioners' modified adjusted gross income was greater

than $150,000, with the result that the $25,000 offset was phased

out.5

        Petitioners argue that they meet the requirements of the

section 469 material participation test in that the rental

properties were petitioners' former homes rented out and

petitioner materially participated in their active management.

Additionally, petitioner contends that, pursuant to section

469(i), their passive losses should be exempted by the $25,000

offset (to the extent of the phaseout) for rental real estate

activities.

        Respondent argues that the exception provided in section

469(c)(7) for certain taxpayers who materially participate in a

real property business does not apply to the years in issue.        We

agree.     Section 469(c)(2) provides the general rule that the term

"passive activity" includes any rental activity.       Section

469(c)(4) provides that section 469(c)(2) is to be applied

without regard to whether or not the taxpayer materially

participates in the activity.     For taxable years beginning after


4
 (...continued)
     not exceed $25,000.
5
        Sec. 469(i)(3)(A) provides:

             (A) In general.--In the case    of any taxpayer, the
        $25,000 amount under paragraph (2)   shall be reduced
        (but not below zero) by 50 percent   of the amount by
        which the adjusted gross income of   the taxpayer for the
        taxable year exceeds $100,000.
                              - 10 -

December 31, 1993, section 469(c)(7) provides an exception to the

general rule in section 469(c)(2) for taxpayers meeting certain

conditions.6   The taxable years in issue in the instant case,

however, are 1990 and 1991.   Accordingly, the section 469(c)(7)

exception does not apply in the instant case.

     Respondent argues that, for purposes of the $25,000 offset

for rental real estate, petitioners have not established that

they "actively participated" in their rental real estate

activities as required by section 469(i).    In the instant case,

however, respondent phased out the $25,000 offset because

petitioners' modified adjusted gross income exceeded $150,000 for

each of the taxable years in issue.    As petitioners provide no

further arguments as to their passive losses, we sustain

respondent's determinations, to the extent that the $25,000


6
     Sec. 469(c)(7) provides, for taxpayers meeting the
requirements of sec. 469(c)(7)(B), that

          (A) In general.--If this paragraph applies to any
     taxpayer for a taxable year --

               (i) paragraph (2) shall not apply to any
          rental real estate activity of such taxpayer
          for such taxable year, and

               (ii) this section shall be applied as if
          each interest of the taxpayer in rental real
          estate were a separate activity.

     Notwithstanding clause (ii), a taxpayer may elect to treat
     all interests in rental real estate as one activity.
     Nothing in the preceding provisions of this subparagraph
     shall be construed as affecting the determination of whether
     the taxpayer materially participates with respect to any
     interest in a limited partnership as a limited partner.
                                  - 11 -

offset is phased out once the Rule 155 computations that we order

below are made.    Rule 142(a).

     As stated in our findings of fact, after concessions and the

application of statutory limitations, the amount of disallowed

deductions in issue is $4,934.      Respondent argues that

petitioners have not substantiated their deduction for real

estate taxes to the extent of $1,384 and their deduction for

charitable contributions to the extent of $3,548 ($2 mathematical

error).   Petitioners argue that their deductions are established

by the canceled checks presented by petitioner at the audit

level.    Additionally, petitioners argue that, as respondent

disallowed many of the checks at the audit level on the grounds

that petitioners could have received a personal benefit, it is

impossible for petitioners to prove that they did not receive

such a benefit.

     In the instant case, petitioners provided no books, records,

or checks substantiating the disallowed deductions.      As to the

checks petitioner claims to have presented at the audit level, we

decide petitioners' liability for income tax deficiencies on the

evidence produced at trial and not a previous record developed at

the administrative level.    Greenberg's Express, Inc. v.

Commissioner, 62 T.C. 324 (1974).      On the basis of the record in

the instant case, we conclude that petitioners have not carried

their burden of substantiating the amount and purpose of the

disallowed deductions.    Accordingly, we sustain respondent's
                              - 12 -

disallowance of Schedule A deductions to the extent of $4,934 for

petitioners' 1991 taxable year.

     We next decide whether petitioners have failed to report

certain income for taxable year 1990 and whether petitioners have

overreported income for taxable year 1991.7   Respondent increased

by $159,282 petitioners' gross income for their 1990 taxable year

to coincide with the amount reported on petitioner's Form W-2

from MBL and decreased petitioners' gross income by $41,512 for

their 1991 taxable year.8   At trial, Peter J. Gelcius, the Agency

Finance Supervisor of MBL Life Assurance Co. (formerly MBL),

testified that, on the basis of his review of MBL's business

records, MBL made payments to petitioner in the amount of

$468,218.34 for 1990 and in the amount of $98,726.62 for 1991.

Additionally, Mr. Gelcius testified that the checks from MBL were

made out to petitioner and that, in petitioner's file at MBL,

there was no assignment of petitioner's income.

     A copy of petitioner's Form W-2 from MBL was admitted in

evidence, solely for the purpose of establishing that petitioner

received a Form W-2 from MBL which stated that during 1990 MBL

paid wage income in the amount of $468,218.34 to petitioner.

Additionally, respondent introduced, solely for impeachment



7
     Respondent raised this issue as a new matter in the amended
answer and, accordingly, bears the burden of proof. Rule 142(a).
8
     Petitioners did not agree that they overreported income for
their 1991 taxable year.
                               - 13 -

purposes, certain business records of MBL which stated that,

during 1990, MBL paid to petitioner wage income in the amount of

$468,218.34.

     Petitioners contend that, during 1990, petitioner received

no wage income from MBL but did receive $308,936 from Stuart

Financial Planning Corp. (Stuart).      Petitioners argue that, at

the audit, they established that MBL paid Stuart, which paid

$308,936 to petitioner.   Additionally, petitioners argue that

they reported income that was deposited in petitioners' account

at NationsBank for their 1990 taxable year.       Alternatively,

petitioners argue that petitioner merely collected income in the

role of agent and, therefore, is not required to include that

amount in gross income.

     Respondent has shown that, during taxable years 1990 and

1991, petitioner received from MBL wage income in the amounts of

$468,218.34 and $98,726.62, respectively.      Mr. Gelcius testified

that MBL made payments to petitioner in the amount of $468,218.34

for 1990 and in the amount of $98,726.62 for 1991.      Mr. Gelcius'

testimony as to the payments made to petitioner during 1991 is

corroborated by the parties' stipulation that petitioner received

from MBL wages in the amount of $98,726.      Additionally, at trial,

Mr. Gelcius' testimony was neither discredited nor contradicted

by petitioner.

     Petitioners argue that MBL paid Stuart, which then paid

petitioner.    At trial, however, petitioner did not present
                              - 14 -

evidence that disputed Mr. Gelcius' testimony that MBL made

payments to petitioner.   The only questions that petitioner asked

Mr. Gelcius concerning the issue were:    (1) "Do you have any

knowledge of me actually physically receiving the check and

depositing it in my bank account?", to which he responded:      "I

was not asked to check on that.    But no, I don't.   But I could

have, though", and (2) "So as far as you know, this check could

have gone to Angelo Scharelli [the agency manager for the MBL

division in south Florida], who in turn deposits [it] in a master

bank account?", to which Mr. Gelcius responded:    "I have no

knowledge of where that check would have went out.     All I know is

that it would have been sent to Nicholas A. Paleveda."      Mr.

Gelcius' testimony was uncontroverted.

     Petitioners argue that they established at the audit that

MBL paid Stuart, which then paid $308,936 to petitioner.     We,

however, decide petitioners' liability for income tax

deficiencies on the evidence produced at trial and not a previous

record developed at the administrative level, Greenberg's

Express, Inc. v. Commissioner, supra, and petitioners did not

offer any documentary evidence establishing that MBL paid Stuart

and that Stuart paid petitioner.    Additionally, petitioners did

not provide any account statements from NationsBank or other

documentary evidence to establish that petitioner received only

$308,936 in income during 1990.    Finally, petitioners offered no

documentary evidence establishing that petitioner merely
                                - 15 -

collected income in the role of agent.

     On the basis of the record in the instant case, we conclude

that during 1990, petitioner received from MBL wage income in the

amount of $468,218.34.   Respondent has conceded that petitioners

are entitled to a decrease in their gross income for 1991 to the

tent of $41,512.9   Accordingly, we sustain respondent's

determinations.

     The next issue to be decided is whether petitioners are

entitled to a bad debt deduction pursuant to section 166(a)(1)

for the worthlessness of an alleged loan.    Petitioners argue that

the $30,000 payment to Mr. Razon during 1986 was a loan that was

made in connection with petitioner's trade or business and that

became worthless during 1991.    Respondent contends that

petitioners have not established that a debtor-creditor

relationship existed between petitioner and Mr. Razon.

Alternatively, respondent argues that, if a debtor-creditor

relationship existed, petitioners have not established that the


9
     In their brief, petitioners argued that, for 1991, they are
entitled to decrease their gross income to the extent of $87,159,
which petitioners allege is an amount that was characterized by a
Florida State court as a loan by MBL to petitioner. Respondent,
noting the decrease in petitioners' income for 1991 to the extent
of $41,512, argues that the issue was not raised in the petition
or at trial. We agree. Generally, we do not consider new issues
raised for the first time on brief. Rollert Residuary Trust v.
Commissioner, 80 T.C. 619, 636 (1983), affd. on other issues 752
F.2d 1128 (6th Cir. 1985); Markwardt v. Commissioner, 64 T.C.
989, 997 (1975); Estate of Mandels v. Commissioner, 64 T.C. 61,
73 (1975). Accordingly, in the instant case, we will not address
the issue of excluding the alleged loan in the amount of $87,159
from gross income.
                              - 16 -

debt became worthless during 1990.

     Section 166(a)(1) provides, in general, for the deduction of

debts that become wholly worthless during a taxable year.    The

bad debt deduction is limited to a bona fide debt; that is, a

debt that arises from a debtor-creditor relationship based upon a

valid and enforceable obligation to pay a fixed or determinable

sum of money.   Sec. 1.166-1(c), Income Tax Regs.   For purposes of

section 166, a contribution to capital is not considered a debt.

In re Uneco, Inc., 532 F.2d 1204, 1207 (8th Cir. 1976); Kean v.

Commissioner, 91 T.C. 575, 594 (1988); sec. 1.166-1(c), Income

Tax Regs.

     Characterization of an advance as either a loan or a capital

contribution is a question of fact which must be answered by

reference to all of the evidence, with the burden on the taxpayer

to establish that the alleged loans were bona fide debts.    Rule

142(a); Dixie Dairies Corp. v. Commissioner, 74 T.C. 476, 493

(1980); Yale Ave. Corp. v. Commissioner, 58 T.C. 1062, 1073-1074

(1972).   Objective factors are to be considered, and the

taxpayer's subjective intent alone is not conclusive of the issue

of characterizing an advance as debt or equity.     In re Uneco,

Inc., supra at 1209.

     Deductions are a matter of legislative grace, and

petitioners bear the burden of proving that they are entitled to

the deductions claimed.   Rule 142(a); INDOPCO, Inc. v.

Commissioner, 503 U.S. at 84; New Colonial Ice Co. v. Helvering,
                                - 17 -

292 U.S. 435 (1934).   Taxpayers are required to maintain records

that are sufficient to enable the Commissioner to determine their

correct tax liability.   See sec. 6001; Meneguzzo v. Commissioner,

43 T.C. at 831-832; sec. 1.6001-1(a), Income Tax Regs.    Moreover,

a taxpayer who claims a deduction bears the burden of

substantiating the amount and purpose of the item claimed.

Hradesky v. Commissioner, 65 T.C. at 90; sec. 1.6001-1(a), Income

Tax Regs.

     On the basis of the record in the instant case, we conclude

that petitioner has not established that the $30,000 payment to

Mr. Razon was bona fide debt.    Although petitioner testified that

he made a loan to Mr. Razon, petitioner's subjective intent alone

is not conclusive of the issue of characterizing an advance as

debt or equity.   In re Uneco, Inc., supra.   Petitioners provided

no documentary evidence corroborating the payment as a loan.

     Several considerations support our conclusion that

petitioner's payment to Mr. Razon was not a bona fide debt.

Petitioner testified that he and Mr. Razon did not execute a note

or establish a loan amortization schedule.    The agreement

provides that "BEN D. RAZON * * * does hereby irrevocably assign,

transfer and set over to * * * [petitioner] a proportionate share

of his right, title and interest in the above referenced

Partnership".   Additionally, pursuant to the agreement, the

parties agreed "to execute any and all documents necessary or

appropriate to transfer their interests hereby conveyed or to be
                               - 18 -

conveyed to the Partnership interest in the property."   The check

written by petitioner to Mr. Razon includes in the memo section

the notation "Partnership Interest".    Accordingly, the foregoing

considerations dissuade us from concluding that petitioner's

$30,000 payment was a loan as opposed to something else, e.g.,

the purchase of a partnership interest in Med-Center.

Consequently, we conclude that petitioners have not established

that the $30,000 payment to Mr. Razon constitutes a bona fide

debt that is deductible as a business bad debt.   Petitioners have

not advanced any other theory upon which a deduction could be

premised.   Accordingly, we hold that petitioners are not entitled

to a bad debt deduction in the amount of $30,000.

     Lastly, we turn to the accuracy-related penalties determined

by respondent.10   In the notice of deficiency, respondent

determined that, on the basis of all of the adjustments in the

notice of deficiency, petitioners were liable for penalties

pursuant to section 6662(a) for taxable years 1990 and 1991.    In

the amended answer, to reflect the adjustments related to

petitioners' underreporting and overreporting of income,

respondent increased the penalty for taxable year 1990 and

decreased the penalty for taxable year 1991.   Accordingly, the



10
      In their brief, petitioners argue that the sec. 6651(a)(1)
additions to tax should be reduced. At trial, however,
petitioners conceded the additions to tax. See supra note 1.
Accordingly, we do not consider petitioners' argument. In any
case, petitioners offered no evidence on the issue. Rule 142(a).
                               - 19 -

increase in the penalty attributable to petitioners'

underreporting of income for 1990 is a new matter within the

meaning of Rule 142(a), for which respondent bears the burden of

proof.    Respondent, however, made no argument on brief regarding

the increase.    Consequently, we consider the increase in the

penalty attributable to petitioners' underreporting of income for

1990 to have been conceded by respondent.    Rybak v. Commissioner,

91 T.C. 524, 566 (1988).

     Section 6662(a) imposes a 20-percent penalty on the portion

of an underpayment of tax that is attributable to, inter alia,

(1) negligence or disregard of rules or regulations or (2) any

substantial understatement of income tax.    The term "negligence"

includes any failure to make a reasonable attempt to comply with

the provisions of the Code, including failure to exercise due

care, failure to do what a reasonable person would do under the

circumstances, or failure to keep adequate books and records or

to substantiate items properly.    Sec. 1.6662-3(b)(1), Income Tax

Regs.    The term "disregard" includes any careless, reckless, or

intentional disregard of the Code or the temporary or final

regulations issued pursuant to the Code.    Sec. 6662(c); sec.

1.6662-3(b)(2), Income Tax Regs.    A substantial understatement of

tax is defined as the amount which exceeds the greater of 10

percent of the tax required to be shown on the return for the

taxable year or $5,000.    Sec. 6662(d)(1)(A).

     The accuracy-related penalty does not apply to any portion
                                - 20 -

of an underpayment with respect to which it is shown that there

was a reasonable cause and that the taxpayer acted in good faith.

Sec. 6664(c)(1).   The decision as to whether the taxpayer acted

with reasonable cause and in good faith depends upon all

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

Tax Regs.   The most important factor is the extent of the

taxpayer's efforts to assess the proper tax liability.       Id.

Circumstances that may indicate reasonable cause and good faith

include an honest misunderstanding of fact or law that is

reasonable in light of the experience, knowledge, and education

of the taxpayer.   Id.    Petitioners must establish error in

respondent's determination that they are liable for the penalty

provided pursuant to section 6662(a).      Rule 142(a); Estate of

Monroe v. Commissioner, 104 T.C. 352, 366 (1995).

     As to the penalties determined by respondent in the notice

of deficiency, petitioners contend that they are not liable

because, at the audit, they produced canceled checks in support

of their deductions.     Additionally, petitioners argue that

respondent required evidence beyond petitioners' checks that, in

some cases, was impossible to produce.      Finally, petitioners

contend that there was no negligence and that they acted in good

faith.

     We conclude that petitioners have not established error in

respondent's determination that they are liable for the section

6662(a) penalty.   The section 6662(a) penalty does not apply to
                                 - 21 -

any portion of an underpayment with respect to which it is shown

that there was a reasonable cause and that the taxpayer acted in

good faith.   Sec. 6664(c)(1).    We conclude that the presentation

of canceled checks by petitioners at the audit, standing alone,

does not establish that there was reasonable cause for the

portion of the underpayment or that petitioners acted in good

faith with respect to that portion.       Additionally, petitioners'

mere allegation that, in the instant case, they were not

negligent and that they acted in good faith does not meet the

requirements of section 6664(c).     Petitioners have provided no

other evidence upon which a finding of reasonable cause and good

faith could be premised.   Accordingly, we sustain respondent's

determination of a section 6662(a) penalty as to the deficiency

which is calculated in the Rule 155 computations that we order

below.

     We have considered all of petitioners' remaining arguments

and find them to be without merit.

     To reflect the foregoing,

                                      Decision will be entered

                                 under Rule 155.
