                        T.C. Memo. 2008-289


                      UNITED STATES TAX COURT



         DANIEL J. AND BRENDA J. STADNYK, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent




     Docket No. 11296-05.                Filed December 22, 2008.



     Michael D. Kalinyak, for petitioners.

     Alisha M. Harper, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     GOEKE, Judge:   The issue for decision arises from petitioner

wife’s receipt of settlement proceeds of $49,000.   Respondent

determined a deficiency of $13,119 for 2002 and an accuracy-
                                 - 2 -

related penalty of $2,624 under section 6662.1    The issues for

decision are:   (1) Whether petitioners may exclude the settlement

proceeds received by petitioner wife from their gross income

pursuant to section 104(a)(2).    We hold the settlement award is

gross income and not excludable; and (2) whether petitioners are

liable for an accuracy-related penalty under section 6662 for

their failure to report the settlement proceeds.    We hold they

are not.

                         FINDINGS OF FACT

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

The stipulation of facts and the attached exhibits are

incorporated herein by this reference.    At the time they filed

the petition, petitioners resided in Kentucky.

     On December 11, 1996, petitioners purchased a used 1990 Geo

Storm from Nicholasville Road Auto Sales, Inc. (Nicholasville

Auto), for their son for $3,430.    Petitioner wife tendered two

checks to Nicholasville Auto in partial payment for the car,

check No. 1080 for $100 and check No. 1087 for $1,100, from a

checking account with Bank One, Kentucky, N.A. (Bank One).

Petitioner husband had visited Nicholasville Auto on multiple

occasions to search for a used car for his son.    On one visit to

the dealership petitioner husband attempted to test drive the Geo


     1
      Unless otherwise indicated, all section references are to
the Internal Revenue Code.
                                 - 3 -

Storm, but it was not running.    Petitioner husband returned to

the dealership, and a salesman informed him that the car had been

repaired.    Petitioner husband test drove the car around the lot,

found that it was working, and decided to purchase the car.

Unfortunately, the car broke down within minutes of leaving

Nicholasville Auto, approximately 7 miles from the dealership.

Petitioners had the car repaired at a cost of $479.78.

Petitioners attempted to contact Nicholasville Auto about the Geo

Storm.    However, their calls were ignored, placed on hold for

long periods of time, and not returned.

     Because of their dissatisfaction with the car, petitioner

wife contacted Bank One to place a stop payment order on the

$1,100 check.    The stop payment order indicated “dissatisfied

purchase” as the reason for the stop payment order.    After the

stop payment order, Bank One incorrectly stamped the check “NSF”

for insufficient funds and returned the check to Nicholasville

Auto.    On February 4, 1997, Nicholasville Auto filed a criminal

complaint against petitioner wife for issuing and passing a

worthless check in the amount of $1,100.    At approximately 6 p.m.

on February 23, 1997, officers of the Fayette County Sheriff’s

Department arrested petitioner wife at her home in the presence

of her husband, her daughter, and a family friend.    Petitioner

wife was taken to the Fayette County Detention Center.    She was

handcuffed, photographed, and confined to a holding area.    At
                                - 4 -

approximately 11 p.m., petitioner wife was handcuffed and

transferred to the Jessamine County Jail, where she was searched

via pat-down and with the use of an electric wand.    She was

required to undress to her undergarments, remove her brassiere in

the presence of police officers, and wear an orange jumpsuit.

Petitioner wife was released on bail at approximately 2 a.m. on

February 24, 1997.    On April 23, 1997, petitioner wife was

indicted for “theft by deception over $300.00” as a result of the

returned check marked for insufficient funds.    These charges were

subsequently dropped.

     Petitioner wife did not suffer any physical injury as a

result of her arrest and detention, except that she was

physically restrained against her will and subjected to police

arrest procedures.    Petitioner wife has stated that she was not

grabbed, jerked around, bruised, or physically harmed as a result

of her arrest or detention.    Petitioner wife visited a

psychologist approximately eight times over 2 months as a result

of this incident.    The costs of these visits were covered by

petitioner wife’s insurance and employer.    She did not have any

out-of-pocket medical expenses for physical injury or mental

distress suffered as a result of her arrest and detention.

     On August 25, 1999, petitioner wife filed a complaint

against (1) J.R. Maze, the sole owner of Nicholasville Auto; (2)

Nicholasville Auto; and (3) Bank One.    On July 5, 2000, she filed
                                - 5 -

a first amended complaint.    She alleged that Bank One breached a

fiduciary duty of care owed to her by improperly and negligently

marking check No. 1087 “NSF” for insufficient funds.    The first

amended complaint alleges damages against Bank One as follows:

       including, but not limited to, nominal damages,
       compensatory damages and special damages, including,
       but not limited to, attorney’s fees to defend, lost
       time and earnings, mortification and humiliation,
       inconvenience, damage to reputation, emotional
       distress, mental anguish, and loss of consortium.

       As against J.R. Maze and Nicholasville Auto, the first

amended complaint seeks the above damages in addition to punitive

damages for their actions relating to alleged fraudulent

misrepresentations relating to the condition of the Geo Storm and

filing the criminal case against petitioner wife.    The first

amended complaint bases its claim for damages against J.R. Maze

and Nicholasville Auto on the following counts:    Malicious

prosecution, abuse of process, false imprisonment, defamation,

and outrageous conduct.    The first amended complaint repeats and

incorporates by reference these allegations with respect to Bank

One.

       On March 7, 2002, petitioner wife entered into a mediation

agreement with Bank One, under which Bank One agreed to pay

petitioner wife the sum of $49,000 in settlement of the complaint

against it and to provide a letter of apology to petitioner wife.

Petitioner wife agreed to the dismissal of her complaint against

Bank One.    On March 14, 2002, Bank One issued a check to
                               - 6 -

petitioner wife for $49,000.   On May 3, 2002, petitioner wife’s

complaint against Bank One was dismissed with prejudice pursuant

to an agreed order.   Petitioner wife’s claims against J.R. Maze

and Nicholasville Auto had been dismissed with prejudice pursuant

to an agreed order entered on June 8, 2001.   There is no

information in the record relating to the terms of the agreed

order dismissing the counts against Nicholasville Auto or J.R.

Maze.

     During the mediation discussions, petitioner wife’s attorney

informed petitioners that the settlement proceeds would not be

taxed.   The mediator and the attorney for Bank One also stated

that the settlement proceeds would not be subject to Federal

income tax.   Petitioner husband prepared petitioners’ 2002 Form

1040, U.S. Individual Income Tax Return, as he had done for over

40 years, using a commercial tax software program.   Petitioner

husband understood that settlement proceeds were not taxable and

was not aware that a distinction was made for tax purposes for

different types of settlements.   Petitioners did not obtain any

professional tax advice beyond the statements made by their

attorney, the mediator, and the attorney for Bank One regarding

whether or not the settlement proceeds were taxable.   Petitioner

wife received Form 1099-MISC, Miscellaneous Income, from Bank One
                               - 7 -

reporting the payment of the $49,000 settlement for the 2002 tax

year.   Petitioners did not report the settlement proceeds on

their 2002 tax return.

     Respondent issued a notice of deficiency to petitioners on

March 14, 2005, determining that for their 2002 tax year

petitioners were liable for a tax deficiency of $13,119 and an

accuracy-related penalty under section 6662(a) of $2,624.

                              OPINION

I.   Settlement Proceeds

     The issue for decision requires an analysis of whether the

settlement proceeds petitioner wife received qualify for the

statutory exclusion from gross income under section 104(a)(2).

Except as otherwise specifically provided, gross income includes

“all income from whatever source derived”.   Sec. 61(a).   Section

61(a) is broadly construed; conversely, statutory exclusions from

income, such as section 104(a)(2), are narrowly construed.

Commissioner v. Schleier, 515 U.S. 323, 327 (1995).

     Section 104(a)(2) excludes from gross income damages

received on account of personal physical injury or physical

sickness.   In order to qualify for income exclusion under section

104(a)(2), taxpayers must satisfy a two-prong test:   (1) The

underlying cause of action giving rise to the settlement award

must be based upon tort or tort type rights, and (2) the damages

must be received on account of personal physical injuries or
                                 - 8 -

physical sickness.     Sec. 104(a)(2); Commissioner v. Schleier,

supra at 336-337; sec. 1.104-1(c), Income Tax Regs.     The Small

Business Job Protection Act of 1996, Pub. L. 104-188, sec. 1605,

110 Stat. 1838, amended section 104(a)(2) to require that

personal injuries or sickness be physical for the taxpayer to

qualify for the section 104(a)(2) income exclusion.     For purposes

of section 104(a)(2), emotional distress is not treated as a

physical injury or physical sickness, except for damages not in

excess of the cost of medical care attributable to emotional

distress.   Sec. 104(a) (flush language).    Damages received in

settlement of economic rights arising out of a contract are not

excludable under section 104(a)(2).      Robinson v. Commissioner,

102 T.C. 116, 126 (1994), affd. in part and revd. in part on

another issue 70 F.3d 34 (5th Cir. 1995); Stocks v. Commissioner,

98 T.C. 1, 9 (1992).     The parties dispute whether the settlement

proceeds satisfy either prong of this two-part test.

     Where damages are received pursuant to a settlement

agreement, the tax consequences of the settlement depend on the

nature of the claim that was the basis for the settlement, rather

than the validity of the claim.     United States v. Burke, 504 U.S.

229, 239 (1992); Robinson v. Commissioner, supra at 126.     The

determination of the nature of the underlying claim is a factual

one and is generally made by reference to the settlement

agreement considered in the light of the facts and circumstances
                               - 9 -

surrounding the settlement.    Robinson v. Commissioner, supra at

126; Knoll v. Commissioner, T.C. Memo. 2003-277.    When the

settlement agreement allocates the damage award to the underlying

claims, that allocation is generally binding for tax purposes to

the extent the parties entered into the agreement in an

adversarial context, at arm’s length, and in good faith.

Threlkeld v. Commissioner, 87 T.C. 1294, 1306-1307 (1986), affd.

848 F.2d 81 (6th Cir. 1988).   When the settlement agreement lacks

express language that identifies the basis for the settlement

award, the Court considers the details surrounding the underlying

proceedings, the allegations in the complaint, the arguments made

by the parties, and the settlement discussions between the

parties.   Robinson v. Commissioner, supra at 127; Threlkeld v.

Commissioner, supra.   The most important factor in determining

the nature of the claim is the intent of the payor in making the

payment.   Stocks v. Commissioner, supra at 10.

     A.    The Nature of Petitioner Wife’s Claims

     The first requirement for the section 104(a)(2) income

exclusion is the existence of a claim based upon tort or tort

type rights.   The term “tort” has been defined broadly as “A

civil wrong, other than breach of contract, for which a remedy

may be obtained, usu. in the form of damages” or “a breach of a

duty that the law imposes on persons who stand in a particular

relation to one another.”   Black’s Law Dictionary 1526 (8th ed.
                                - 10 -

2004).    The limitation of the exclusion to claims arising in tort

or tort type rights necessitates a consideration of State law.

Threlkeld v. Commissioner, supra at 1305-1306.       State law

determines whether the nature of the legal claim is a tort or

tort type right, and Federal law controls the Federal tax

consequences.     Bland v. Commissioner, T.C. Memo. 2000-98.

       The parties disagree as to what legal claims petitioner wife

asserted against Bank One and whether the asserted claims were

based on tort or tort type rights.       The mediation agreement did

not state the basis for the award or allocate the award in any

way.     The record does not contain any information concerning the

mediation process to assist us in determining the basis of the

mediation award.     Rather, the parties focus on petitioner wife’s

allegations in her complaint.     Respondent contends that the only

claim that petitioner wife asserted against Bank One was for

breach of a fiduciary duty of care based on its erroneous marking

of the $1,100 check for insufficient funds.      Petitioners contend

that the settlement proceeds were paid on account of petitioner

wife’s physical restraint and detention, which constituted the

tort of false imprisonment.

       As respondent points out, petitioner wife asserted only one

count against Bank One alone.     However, petitioner wife asserted

numerous counts against codefendants J.R. Maze and Nicholasville

Auto, including false imprisonment, malicious prosecution, abuse
                              - 11 -

of process, and defamation.   The first amended complaint

specifically repeats and incorporates by reference each of these

counts against Bank One.   This incorporation by reference is

sufficient for us to find that petitioner wife alleged a claim of

false imprisonment against Bank One.

     Although petitioners rely heavily on the false imprisonment

claim to support the applicability of section 104(a)(2),

petitioner wife also alleged the torts of negligence and breach

of fiduciary duty against Bank One.    Respondent characterizes

those claims as based on contract under State law, citing Bank of

Louisville Royal v. Sims, 435 S.W.2d 57, 58 (Ky. Ct. App. 1968).

However, it is not as clear as respondent would have us believe

that a lawsuit arising from a bank and customer relationship is

based on contract alone.   The Kentucky banking statute recognizes

elements of both contract and tort in the bank-depositor

relationship.   See Bullitt County Bank v. Publishers Printing

Co., 684 S.W.2d 289, 291-292 (Ky. Ct. App. 1984).    The banking

statute imposes a duty on banks to exercise good faith and

ordinary care in handling customer accounts, a duty which

inherently incorporates common law rules of negligence.     Pulliam

v. Pulliam, 738 S.W.2d 846, 849 (Ky. Ct. App. 1987).    The remedy

for a breach of a duty imposed by law is not necessarily confined

to a contract claim.   Am. Natl. Bank v. Morey, 69 S.W. 759, 760

(Ky. Ct. App. 1902).   Specifically, Morey recognizes that a bank
                                 - 12 -

customer may have a tort claim for a wrongful dishonor of a

check.    Id.   Negligence in the performance of a contract can give

rise to a tort where the negligence breached a duty owed by the

defendant independent of the contract.      Mims v. W.-S. Agency,

Inc., 226 S.W.3d 833, 836 (Ky. Ct. App. 2007).     Petitioner wife

had a right under the State banking statute to stop payment on

the check.      See Ky. Rev. Stat. Ann. sec. 355.4-403(1) (LexisNexis

2008).    Thus, Bank One owed petitioner wife certain duties

imposed under the State banking statute.     Negligence in the

performance of those duties could give rise to a tort claim

sufficient to satisfy the first prong of the section 104(a)(2)

income exclusion.

     Respondent contends that Bank One’s liability to petitioner

wife is based on Ky. Rev. Stat. Ann. sec. 355.4-402 (LexisNexis

2008).    That section provides a cause of action by a customer

against a bank that wrongfully dishonors the customer’s check.

The statute does not specify a theory for a bank’s liability for

wrongful dishonor.     See also U.C.C. sec. 4-402, Official Comment

2 (2008) (recognizing dishonor may be based on contract, tort, or

both). Courts have recognized that a depositor’s claim for

wrongful dishonor of a check may give rise to a cause of action

in contract or tort, or both.     Schwartz, Annotation, “Liability

of Bank to Depositor for Dishonoring a Check”, 126 A.L.R. 206

(1940).    Thus, this statute does not provide conclusive support
                                - 13 -

for respondent’s characterization of petitioner wife’s complaint

against Bank One as a contract claim.    Moreover, neither the

complaint nor the first amended complaint cites this statute as

the basis for petitioner wife’s cause of action against Bank One.

Wrongful dishonor occurs when a bank refuses to pay a check drawn

upon it by a customer with sufficient funds to cover the check.

By placing a stop payment order, petitioner wife asked Bank One

not to honor the $1,100 check.    The similarity between Bank One’s

failure to adhere to the stop payment order and a wrongful

dishonor is that Bank One’s mistake exposed petitioner wife to

arrest and prosecution.   Ky. Rev. Stat. Ann. sec. 355.4-402

specifically recognizes that a wrongful dishonor may proximately

cause the customer’s arrest, which is a reasonably foreseeable

consequence of the wrongful dishonor.    Thus, it recognizes that

while Bank One may not have initiated the criminal action against

petitioner wife, its handling of the $1,100 check may have

proximately caused her arrest.

     It is incorrect to characterize petitioner wife’s complaint

against Bank One as a contract claim or merely a dispute over the

wrongful dishonor of a check.    Rather, petitioner wife decided to

sue Bank One because of the ordeal she suffered as a result of

her arrest and detention.   Petitioner wife did not suffer an

economic loss from Bank One’s alleged mishandling of her check.

She did not sue Bank One to recover on economic rights arising
                              - 14 -

from a contract with Bank One.   Petitioner wife sought damages

against Bank One that resulted from her arrest, detention, and

indictment.   She alleged damages associated with tort type

rights:   Emotional distress, mental anguish, mortification,

humiliation, and damage to reputation.    Although Bank One did not

initiate the criminal proceedings against petitioner wife, the

erroneous marking of the check for insufficient funds

precipitated the arrest.   Bank One entered into the settlement

agreement with an intent to resolve claims for tort type rights.

Accordingly, we find that petitioner wife received the settlement

for claims based on tort or tort type rights.

     B.    Physical Injury or Physical Sickness

     The second requirement for income exclusion under section

104(a)(2) is that the settlement proceeds be paid on account of

physical injury or physical sickness.    Congress amended section

104(a)(2) in 1996 to distinguish between physical injuries and

nonphysical injuries and specifically limited the availability of

the section 104(a)(2) income exclusion to physical injuries for

payments made after August 20, 1996.    The amendment overruled

court decisions that exempted payments for nonphysical injuries

from gross income.   H. Conf. Rept. 104-737, at 301 (1996), 1996-3

C.B. 741, 1041.   Before the 1996 amendment, the Court of Appeals

for the Sixth Circuit, to which this case is appealable, held

that damages received on account of a personal nonphysical injury
                              - 15 -

were excludable under section 104(a)(2).    See Threlkeld v.

Commissioner, 848 F.2d 81 (6th Cir. 1988).     The terms “physical

injuries” and “physical sickness” do not include emotional

distress, except for damages not in excess of the cost of medical

care attributable to emotional distress.    Sec. 104(a) (flush

language).

     Petitioner wife has admitted that she did not suffer

physical harm during the course of her arrest and detention.     She

was not grabbed, jerked around, or bruised.    Rather, petitioners

argue that physical restraint and detention constitute a physical

injury for purposes of section 104(a)(2).    Petitioners contend

that a person does not have to be cut or bruised for physical

injury to occur under tort law.

     Physical restraint and physical detention are not “physical

injuries” for purposes of section 104(a)(2).    Being subjected to

police arrest procedures may cause physical discomfort.    However,

being handcuffed or searched is not a physical injury for

purposes of section 104(a)(2).    Nor is the deprivation of

personal freedom a physical injury for purposes of section

104(a)(2).   Physical injury is not required for the tort of false

imprisonment to occur.   Kentucky courts define false imprisonment

as “any deprivation of the liberty of one person by another or

detention for however short a time without such person’s consent

and against his will, whether done by actual violence, threats or
                                - 16 -

otherwise.”   Grayson Variety Store, Inc. v. Shaffer, 402 S.W.2d

424, 425 (Ky. Ct. App. 1966).    The tort of false imprisonment

protects personal interest in freedom from physical restraint;

such an interest is “in a sense a mental one”.    Banks v. Fritsch,

39 S.W.3d 474, 479-480 (Ky. Ct. App. 2001).   Injury from false

imprisonment is “in large part a mental one” where the plaintiff

can recover for mental suffering and humiliation.    Id. at 479.

The alleged false imprisonment against petitioner wife did not

cause her to suffer physical injury as required for relief under

section 104(a)(2).

     It seems likely, as petitioners contend, that Bank One

agreed to pay the $49,000 settlement to compensate for the ordeal

that petitioner wife suffered as a result of her arrest,

detention, and indictment.   The damages sought by petitioner wife

against Bank One are stated in terms of recovery for nonphysical

personal injuries:   Emotional distress, mortification,

humiliation, mental anguish, and damage to reputation.    These

types of injuries are not excludable under section 104(a)(2).

See Sanford v. Commissioner, T.C. Memo. 2008-158 (settlement

award for emotional distress relating to sexual harassment and

discrimination claims is not excludable); Polone v. Commissioner,

T.C. Memo. 2003-339 (settlement award for defamation claim is not

excludable), affd. 505 F.3d 966 (9th Cir. 2007); Venable v.

Commissioner, T.C. Memo. 2003-240 (settlement payment for mental
                               - 17 -

anguish and loss of reputation relating to malicious prosecution

claim is not excludable), affd. 110 Fed. Appx. 421 (5th Cir.

2004).    Petitioner wife did not experience a “physical injury” as

required for relief under section 104(a)(2).    For this reason,

the settlement proceeds were not excludable from income under

section 104(a)(2).

     C.     Sixteenth Amendment and Section 61(a) Arguments

     In the alternative, petitioners argue that settlement

proceeds for personal injuries are not gross income within the

meaning of section 61(a) where (A) the settlement was not paid

for lost earnings and (B) petitioners were not enriched by the

settlement.    Petitioners further argue that section 104(a)(2)

conflicts with section 61(a) and violates the Sixteenth Amendment

to the extent that it taxes compensatory damages received for

personal injuries.

     Petitioners’ arguments are similar to those previously

rejected.    See Murphy v. IRS, 493 F.3d 170, 179-180 (D.C. Cir.

2007); Ballmer v. Commissioner, T.C. Memo. 2007-295.    Gross

income includes “all economic gains not otherwise exempted.”

Commissioner v. Banks, 543 U.S. 426, 433 (2005).    Thus,

petitioner wife’s settlement award for personal injury is gross

income under section 61(a).    Section 104(a)(2) does not conflict

with section 61(a) by subjecting damage awards for nonphysical

personal injury to tax.    As this Court has explained in Ballmer,
                                - 18 -

for the flush language of section 104(a) to make sense (defining

emotional distress as a nonphysical injury), the definition of

gross income in section 61(a) must first include damages for

nonphysical injuries.   Section 104(a)(2) does not conflict with

section 61(a).

      Moreover, petitioners’ argument with respect to the

unconstitutionality of section 104(a)(2) is without merit.    See

Murphy v. IRS, supra at 186; Ballmer v. Commissioner, supra.       In

Murphy, the Court of Appeals examined at length the

constitutionality of taxing damage awards for nonphysical

personal injuries.   The court held that the taxation of awards

received for personal, nonphysical injury was within the power of

Congress and that such a tax was not subject to the apportionment

requirement and was uniform.    We see no reason to revisit this

issue here.   See Hawkins v. Commissioner, T.C. Memo. 2007-286.

II.   Section 6662 Penalty

      Respondent determined that petitioners are liable for an

accuracy-related penalty under section 6662 for substantial

understatement of income tax for the 2002 tax year.    Section

6662(a) and (b)(2) imposes a 20-percent penalty on an

underpayment of tax that results from a substantial

understatement of income tax.     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. 6662(d)(1)(A).
                                 - 19 -

     The section 6662 penalty is inapplicable to the extent the

taxpayer had reasonable cause for the understatement and acted in

good faith.   Sec. 6664(c)(1).     The determination of whether the

taxpayer acted with reasonable cause and in good faith is made on

a case-by-case basis, taking into account the relevant facts and

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

“Circumstances that may indicate reasonable cause and good faith

include an honest misunderstanding of fact or law that is

reasonable in the light of all the facts and circumstances,

including the experience, knowledge, and education of the

taxpayer.”    Id.    Generally, the most important factor is the

extent of the taxpayer’s efforts to assess the proper tax

liability.    Id.    An honest misunderstanding of fact or law that

is reasonable in the light of the experience, knowledge, and

education of the taxpayer may indicate reasonable cause and good

faith.   Remy v. Commissioner, T.C. Memo. 1997-72.

Petitioners relied on statements made by their attorney, Bank

One’s attorney, and the mediator during the course of the

mediation conference that the settlement award would not be

subject to Federal income tax.      The mediation agreement did not

contain any statements with respect to the tax treatment of the

settlement.    Petitioners did not seek additional advice regarding

the proper tax treatment of the settlement after receiving the

Form 1099-MISC from Bank One reporting the $49,000 settlement
                               - 20 -

award.   Petitioners received unsolicited advice from three

separate and independent individuals that the settlement would

not be taxed.    At least two of those individuals were

disinterested parties with no relationship with petitioners.

This advice confirmed petitioners’ previous understanding of the

taxation of settlement awards.    Although none of those

individuals had specialized knowledge in tax law, they were

experienced in personal injury lawsuits and settlements.

Petitioners acted reasonably and in good faith when following

their advice and preparing their own return as they have done for

over 40 years.    We find that reasonable persons could disagree as

to whether additional advice was required in this instance.      The

receipt of Form 1099 should not preclude a finding of reasonable

cause.   See Kidd v. Commissioner, T.C. Memo. 2004-135; sec.

1.6662-3(b)(1)(i), Income Tax Regs.     Accordingly, we find that

petitioners are not liable for the section 6662 penalty.

     On the basis of the foregoing,


                                           Decision will be entered

                                      for respondent as to the

                                      deficiency and for petitioners

                                      as to the penalty.
