                          T.C. Memo. 2002-89



                        UNITED STATES TAX COURT



         RONALD J. LUTZ, JR. AND PAULA M. LUTZ, Petitioners v.
              COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 10211-99.               Filed April 4, 2002.


     Michele M. Echols, for petitioners.1

     Emile L. Hebert III and Susan S. Canavello, for

respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


     THORNTON, Judge:    Respondent determined a $37,164 deficiency

in petitioners’ 1996 joint Federal income tax and a $7,349




     1
       At trial, petitioners were represented by Robert L.
Henderson, Jr., who subsequently withdrew.
                               - 2 -

accuracy-related penalty under section 6662(a).2    The issues for

decision are:   (1) Whether petitioners in 1996 had unreported

wagering gains in excess of wagering losses, and if so, the

amount of the excess gains; and (2) whether petitioners are

liable for a penalty under section 6662(a) for substantially

understating their 1996 income tax.

                         FINDINGS OF FACT

     The parties have stipulated some facts, which we incorporate

herein by this reference.   When they petitioned the Court,

petitioners, husband and wife, resided in Slidell, Louisiana.

     During 1996, petitioner husband (Ronald) was president and

part owner of Mega International, Inc. (Mega), an S corporation

which operated an offshore oil field business.3    During 1996,

Ronald earned $80,000 in wages from Mega.   During 1996,

petitioner wife (Paula) did not work outside the home.     Although

Paula was not employed by Mega and otherwise provided no services

to Mega, during 1996 she also received $24,000 from Mega, which

reported the payments to her on a 1996 Form W-2, Wage and Tax

Statement, as wages, tips, or other compensation.


     2
       Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the year in issue, and
all Rule references are to the Tax Court Rules of Practice and
Procedure.
     3
       Unaudited financial statements admitted into evidence
indicate that petitioners owned 49 percent of Mega International,
Inc. (Mega). The record otherwise contains no information about
the ownership of Mega.
                                - 3 -

     In 1996, Ronald’s employment with Mega required him to work

60 to 80 hours per week.    In June 1996, Paula gave birth to

petitioners’ third child.    Despite the demands of their

respective obligations, however, petitioners found time in 1996

for a great deal of recreational gambling.    Two or three times a

week, they went to casinos together.    Once or twice a week, Paula

went to casinos without Ronald.

     Petitioners gambled primarily at the following four casinos:

Casino Magic in Biloxi, Mississippi (Biloxi Casino Magic); Casino

Magic in Bay St. Louis, Mississippi (Bay St. Louis Casino Magic);

Bayou Caddy’s Jubilation Casino in Lakeshore, Mississippi

(Jubilation Casino); and Boomtown Casino in Harvey, Louisiana

(Boomtown Casino).

     When petitioners visited a casino together, they usually

gambled in separate areas, until one of them ran out of money and

went and found the other.    Ronald favored table games; Paula

played both table games and slot machines.    Sometimes Paula would

gamble all day, into the wee hours.     During their gambling trips,

the casinos furnished petitioners, free of charge, meals, hotel

rooms, and such.

     When petitioners went to the casinos, they sometimes brought

substantial amounts of cash for gambling.    Sometimes they

obtained cash at the casinos, either through a line of credit

with the casinos, or by cashing a check, using a credit card, or
                                - 4 -

making automatic teller machine withdrawals.   Sometimes they

would take cash home from the casinos; sometimes they would not.

Except for the $40,000 proceeds of one jackpot that Paula won in

February 1996, petitioners deposited into their checking or

savings accounts none of the cash that they brought home from the

casinos.

     During 1996, petitioners kept no records of their gambling

activities.   Biloxi Casino Magic and Bay St. Louis Casino Magic

(collectively, the Casinos Magic), however, maintained some

records of petitioners’ gambling activities.   With regard to

petitioners’ table games play, these records consist primarily of

computer-generated “Trip History Reports” (THRs), wherein the

casinos’ table games supervisors would estimate and record

petitioners’ “observed” wins and losses on particular dates.

The THRs indicate that during 1996 petitioners had estimated

total winnings and losses at table games in the following

amounts:

                                         Winnings       Losses

     Paula:
          Bay St. Louis   Casino Magic      –-          $32,729
          Biloxi Casino   Magic           $1,250           --
     Ronald:
          Bay St. Louis   Casino Magic    10,850            7,500
          Biloxi Casino   Magic             -–                350

     Employees of the Casinos Magic typically do not “observe”

patrons’ slot machine play, as they do table games play.    The

casinos do, however, make available to their patrons so-called
                               - 5 -

Player’s Club cards--magnetic-strip cards that when inserted into

the casinos’ slot machines electronically track the player’s wins

and losses.   During 1996, Paula had several Player’s Club cards,

but she did not use them because she thought they were a “jinx”.

As far as the record reveals, Ronald also used no Player’s Club

card when he gambled at slot machines.     Consequently, the only

Casinos Magic records of petitioners’ slot machine play are those

that relate to the casinos’ reporting, on Form W-2G, Certain

Gambling Winnings, of slot machine winnings over $1,200.4

     In 1996, the Bay St. Louis Casino Magic issued 24 Forms W-2G

to Paula and one Form W-2G to Ronald, reporting aggregate slot

machine winnings in 1996 of $99,500 ($98,250 for Paula and $1,250

for Ronald) on total bets placed of $4,975–-reflecting a 20-to-1

payoff on each individual jackpot.     In 1996, the Biloxi Casino

Magic issued 10 Forms W-2G to Paula and one Form W-2G to Ronald,

showing aggregate winnings of $39,400 ($37,800 for Paula and

$1,600 for Ronald).5

     During 1996, petitioners also had these other gambling

winnings and losses:




     4
       Forms W-2G, Certain Gambling Winnings, are required to be
issued for table game winnings of $600 or more and for slot
machine winnings of $1,200 or more. Sec. 6041(a); sec. 7.6041-1,
Temporary Income Tax Regs., 42 Fed. Reg. 33286 (June 30, 1977).
     5
       The record does not indicate the amounts of bets placed
with respect to these Biloxi Casino Magic winnings.
                              - 6 -

                                      Winnings      Losses

     Boomtown Casino                   $2,645       $1,690
     Jubilation Casino                  3,100        1,550

     On their 1996 joint Federal income tax return, petitioners

reported no income or losses from their gambling activities.

They reported $104,000 wage income from Mega.

     Respondent commenced an examination of petitioners’ 1996

joint Federal income tax return in December 1998.    In the notice

of deficiency, issued in March 1999, respondent determined that

petitioners had $91,000 unreported gambling income.    Respondent’s

determination was based on gambling winnings reported on 18 Forms

W-2G–-two from Jubilation Casino (showing $3,100 total gross

winnings), eight from the Bay St. Louis Casino Magic (showing

$61,000 total gross winnings), seven from the Biloxi Casino Magic

(showing $24,900 total gross winnings), and one from Boomtown

Casino (showing $2,000 total gross winnings).

                             OPINION

     Petitioners contend that their 1996 gambling losses more

than offset their gambling winnings and that respondent’s

determination is therefore in error.    Respondent concedes that

petitioners had $43,818.75 of gambling losses in 1996, based

largely on the THRs generated by the Casinos Magic with respect

to petitioners’ table games play.   Respondent contends, however,

that petitioners had at least $144,645 of unreported gambling

winnings in 1996, and that the notice of deficiency reflects only
                                 - 7 -

$91,000 of these unreported gambling winnings, thus omitting (for

unexplained reasons) at least $53,645 of these unreported

gambling winnings.    Respondent contends that since the $43,818.75

conceded gambling losses are less than the unreported gross

gambling winnings that were omitted from the notice of

deficiency, petitioners are entitled to no deduction for gambling

losses.6

     Gross income includes all income from whatever source

derived, including gambling.    Sec. 61; McClanahan v. United

States, 292 F.2d 630, 631-632 (5th Cir. 1961).    In the case of a

taxpayer not engaged in the trade or business of gambling,

gambling losses are allowable as an itemized deduction, but only

to the extent of gains from such transactions.    See sec. 165(d);

McClanahan v. United States, supra; Winkler v. United States, 230

F.2d 766 (1st Cir. 1956); Gajewski v. Commissioner, 84 T.C. 980

(1985).

     Absent a statutory exception, petitioners generally bear the

burden of proving their entitlement to claimed deductions.       Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).     When

respondent raises a new matter, however, the burden of proof is

on him.    Rule 142(a).   Accordingly, respondent bears the burden

of establishing the amount of petitioners’ additional unreported



     6
       Respondent does not seek any increased deficiency based on
gambling winnings omitted from the notice of deficiency.
                                - 8 -

gross gambling income that is not reflected in the notice of

deficiency.    See Kalisch v. Commissioner, T.C. Memo. 1986-541,

affd. without published opinion 838 F.2d 461 (3d Cir. 1987).

     In certain circumstances, section 7491 places the burden of

proof on respondent with regard to certain factual issues.

Section 7491 is effective with respect to court proceedings

arising in connection with examinations commencing after July 22,

1998.    Internal Revenue Service Restructuring & Reform Act of

1998, Pub. L. 105-206, sec. 3001(c)(2), 112 Stat. 727.     The

examination in the instant case began in December 1998.

Therefore we evaluate whether respondent bears the burden of

proof pursuant to section 7491.

     Section 7491(a)(1) provides that if, in any court

proceeding, the taxpayer introduces credible evidence with

respect to factual issues relevant to ascertaining the taxpayer’s

liability for a tax (under subtitle A or B), the burden of proof

with respect to such factual issues will be placed on the

Commissioner, provided that various conditions are met.     One of

the conditions is that the taxpayer must comply with the

substantiation and record-keeping requirements of the Internal

Revenue Code.    See sec. 7491(a)(2)(A) and (B).7   Under the


     7
       For the burden to be placed on the Commissioner, the
taxpayer must also cooperate with reasonable requests by the
Commissioner for “witnesses, information, documents, meetings,
and interviews”. Sec. 7491(a)(2)(B). Respondent argues that
                                                   (continued...)
                               - 9 -

Internal Revenue Code, the taxpayer is required to maintain

records that are sufficient to enable the Commissioner to

determine the correct tax liability.   See sec. 6001; sec. 1.6001-

1(a), Income Tax Regs.; see also Rev. Proc. 77-29, 1977-2 C.B.

538 (providing guidance as to acceptable evidence for

substantiating wagering wins and losses).   Here, petitioners do

not dispute that they failed to maintain records of their

gambling activities.   Accordingly, the burden of proof as to

petitioners’ gambling losses is not placed on respondent, and

petitioners bear the burden of substantiating the amount of any

claimed gambling loss deduction.   See Hradesky v. Commissioner,

65 T.C. 87, 90 (1975), affd. 540 F.2d 821 (5th Cir. 1976).

     Moreover, as discussed in greater detail below, although

petitioners have introduced evidence substantiating some losses–-

and respondent has conceded some losses--petitioners have failed

to introduce credible evidence, as required by section 7491(a),



     7
      (...continued)
petitioners fail this requirement, having failed to produce any
documents to substantiate their gambling winnings and losses
after receiving from respondent a December 1998 letter regarding
the examination of their 1996 Federal tax liabilities. Because
we conclude that petitioners have failed the substantiation and
record-keeping requirements of sec. 7491(a)(2)(A) and (B), we
need not decide whether petitioners also fail the cooperation
test.

     The benefits of sec. 7491 are also unavailable if the
taxpayer fails certain net-worth limitations. See sec.
7491(a)(2)(C). Respondent does not argue that petitioners fail
the net-worth limitations.
                               - 10 -

to show that their gambling losses equal or exceed their gambling

winnings.8

     In contending that petitioners had at least $144,645 of

unreported gambling winnings, respondent relies on stipulations

and undisputed evidence which show that petitioners had

unreported gambling winnings from the following sources:

     Boomtown Casino                      $2,645
     Jubilation Casino                     3,100
     Bay St. Louis Casino Magic           99,500
     Biloxi Casino Magic                  39,400
          Total                          144,645

     While we agree (and petitioners do not dispute) that

petitioners had unreported gambling winnings of $144,645,

respondent has not shown that the entire $144,645 represents

gross income to petitioners.   The evidence shows, and we have

found, that the $99,500 gambling winnings from the Bay St. Louis

Casino Magic, as reported on Forms W-2G, were all from slot

machine play and that to win this $99,500, petitioners placed

bets of $4,975.   Therefore, $4,975 of the $99,500 slot machine

winnings is in the nature of a recovery of capital and should be

excluded from petitioners’ gross gambling winnings to arrive at



     8
       Sec. 7491 does not define what constitutes credible
evidence. The pertinent legislative history states: “Credible
evidence is the quality of evidence which, after critical
analysis, the court would find sufficient upon which to base a
decision on the issue if no contrary evidence were submitted
(without regard to the judicial presumption of IRS correctness).”
H. Conf. Rept. 105-599, at 240-241 (1998), 1998-3 C.B. 747, 994-
995; see Higbee v. Commissioner, 116 T.C. 438, 442 (2001).
                                - 11 -

gross income under section 61 and adjusted gross income under

section 62.     See Hochman v. Commissioner, T.C. Memo. 1986-24.

     Similarly, the $39,400 gambling winnings from the Biloxi

Casino Magic is the amount reported as gambling winnings on Forms

W-2G.     The record does not expressly indicate whether these gross

winnings are from slot machine or table games play.    On the basis

of all the evidence in the record, however, we infer that the

$39,400 winnings are all from petitioners’ slot machine play at

the Biloxi Casino Magic.9    Although the evidence does not

expressly indicate the amounts of bets that petitioners placed to

win these jackpots, we believe that it is a fair inference that

the slot machine payoffs for the Bay St. Louis Casino Magic and

the Biloxi Casino Magic were the same; i.e., 20 to 1.

Accordingly, we infer that petitioners placed aggregate bets of

$1,970 to win the $39,400 at the Biloxi Casino Magic.10


     9
       This inference is based on several considerations:
According to the Biloxi Casino Magic Trip History Reports (THRs)
that are in evidence, petitioners had only $1,250 table games
winnings at the Biloxi Casino Magic. The smallest amount of
winnings shown on the Biloxi Casino Magic Forms W-2G, however, is
$1,600. All of petitioners’ winnings as reported on the Forms W-
2G from the Biloxi Casino Magic are in amounts greater than
$1,200–-the slot machine threshold amount–-and are in round
numbers, in amounts similar to those reflected on the Bay
St. Louis Casino Magic Forms W-2G. Since the latter Forms W-2G
clearly relate solely to slot machine play, we infer that the
Biloxi Casino Magic Forms W-2G also relate solely to slot machine
play.
     10
       By contrast, with respect to petitioners’ winnings of
$2,645 and $3,100 from Boomtown Casino in Harvey, La., and
                                                   (continued...)
                              - 12 -

Consequently, petitioners’ cost of winning the $138,900 total

slot machine winnings was $6,945 ($4,975 plus $1,970).

Subtracting this amount from petitioners’ $144,645 gross gambling

winnings (which includes the $138,900 slot machine winnings), we

conclude that the facts relied upon by respondent show that

petitioners had total unreported gross income from gambling of

$137,700.11

     As previously discussed, respondent determined in the notice

of deficiency that petitioners had unreported gambling winnings

of $91,000, of which amount $85,900 represent slot machine

winnings reported on Forms W-2G from the Casinos Magic.

Consistent with our conclusion that these slot machine winnings

reflect payoffs of 20 times the bets placed, it appears that

petitioners’ cost of winning the $85,900 total jackpots was

$4,295.   Excluding this capital-recovery cost from the gross

gambling winnings reflected in the notice of deficiency, we



     10
      (...continued)
Jubilation Casino in Lakeshore, Miss., respectively, the record
contains no basis for inferring either the type of games played
or the bets placed.
     11
       This figure does not include table games winnings
reflected on the Casinos Magic THRs, in amounts of $10,850 for
Ronald and $1,250 for Paula. Nor does this figure otherwise
include any of petitioners’ gross gambling winnings that might
have been under the casinos’ reporting thresholds. Respondent
has not expressly argued that any such additional unreported
winnings should be taken into account. Accordingly, we give them
no further consideration in assessing petitioners’ allowable
gambling losses.
                              - 13 -

conclude that the unreported gross income indicated by the notice

of deficiency is $86,705 ($91,000 less $4,295).

     To recap, we conclude that the facts relied upon by

respondent show that petitioners had unreported gambling gross

income of $137,700.   This amount is $50,995 greater than the

$86,705 unreported gambling gross income indicated by the

unreported gross gambling winnings reflected in the notice of

deficiency.   To establish their entitlement to deduct gambling

losses from the gross gambling income indicated by the notice of

deficiency, petitioners must establish that their gambling losses

are greater than the $50,995 of unreported gross gambling income

that is not reflected in the notice of deficiency.   See Schooler

v. Commissioner, 68 T.C. 867 (1977).   Respondent has conceded

that petitioners have gambling losses of $43,818.75, based

largely on the THRs generated by the Casinos Magic with respect

to petitioners’ table games play.   Accordingly, petitioners must

establish additional gambling losses of at least $7,176.25

($50,995 less $43,818.75) to show entitlement to any gambling

loss deduction.12




     12
       As discussed in more detail in the text, the $43,818.75
gambling losses that respondent has conceded represent primarily
losses reflected in THRs, relating to table games play at the
Casinos Magic. These conceded losses do not include petitioners’
costs of placing slot machine bets and hence do not duplicate the
amounts that we have concluded should be allowed as an offset in
determining petitioners’ gross income from slot machine winnings.
                              - 14 -

     As previously discussed, the notice of deficiency is based

on respondent’s determination that petitioners had unreported

slot machine winnings from the Casinos Magic and a lesser amount

of winnings from the Boomtown Casino and the Jubilation Casino.

The parties have stipulated the amount of gambling losses that

petitioners sustained at Boomtown Casino and Jubilation casino.

Respondent has conceded the Casinos Magic table games losses as

reflected on the THRs.   Accordingly, the essence of the dispute

between the parties is whether petitioners have substantiated

gambling losses with respect to their slot machine play at the

Casinos Magic.

     Having kept no records of losses on their slot machine play

at the Casinos Magic, petitioners rely on two undated letters, on

Bay St. Louis Casino Magic letterhead and signed by Tina

Frederiksen in her capacity as “Casino Magic VIP Representative”.

These letters state that for 1996 Paula had a net loss of $20,910

and Ronald had a net win of $3,350 “in Table Games, Slots, or

combined play”.   The letters contain a number of caveats,

however, including that the casino’s tracking system “is designed

for marketing purposes only”, that the “information should only

be used to support your personal records”, that the casino

“cannot be certain that you used your * * * Player’s Club Card

every time you visited us, or used it correctly”, and that “Table

Game play is not an exact account of actual play; it is strictly
                               - 15 -

an estimate.”   Although Ms. Frederiksen (using her married name

of Cantrell) testified at trial, she offered no testimony

regarding the source or nature of the information contained in

the two letters.

     From the face of the letters, we infer that estimates

therein of petitioners’ net winnings and losses are based on the

casinos’ tracking system.    The evidence shows that the casinos

generally did not track slot machine wins and losses unless the

patron used a Players’ Club card.    Paula testified that she did

not use her Players’ Club cards when she played slot machines

because she thought they were a “jinx.”    Similarly, there is no

evidence that Ronald ever used a Players’ Club Card when he

played slot machines.    Accordingly, we conclude that the letters

are unreliable indicators of petitioners’ gambling winnings and

losses, failing in particular to reflect either slot machine

winnings or losses.   Cf. Mayer v. Commissioner, T.C. Memo. 2000-

295 (similar unsigned letter from Caesar’s Palace, purporting to

estimate the taxpayer’s gambling winnings and losses, was deemed

to be unreliable evidence and given no weight), affd. 2002 U.S.

App. LEXIS 2838 (2d Cir. 2002).

     Petitioners contend that their bank statements and other

documentary evidence show that during 1996 they made cash

withdrawals or debit or credit card charges at the casinos

totaling some $39,329.    Assuming that petitioners made such
                              - 16 -

transactions at the casinos, the mere fact of these transactions

does not substantiate actual losses of those funds on gambling.

See Schooler v. Commissioner, 68 T.C. at 870; Klabacka v.

Commissioner, T.C. Memo. 1987-77.

     Petitioners presented testimony of casino employees,

indicating that the odds of beating the casinos over the long

haul are not good.   We do not doubt it.   Such generalizations,

however, do not tend to substantiate petitioners’ actual gambling

losses or provide us any basis for estimating them.

     Petitioners rely upon Doffin v. Commissioner, T.C. Memo.

1991-114, to establish that they are entitled to deduct gambling

losses.   In Doffin, the taxpayer had $46,240 lottery winnings in

one year and $32,571 in another.    The taxpayer kept no records of

gambling losses.   The Commissioner allowed the taxpayer a

deduction for gambling losses limited to the costs of the winning

lottery tickets ($494) in one of the years at issue.    The

Commissioner allowed the taxpayer no gambling losses for the

other year.   The evidence in Doffin showed that the taxpayer, who

lived in a mobile home and had few assets and little income, had

sold assets and borrowed money during the years at issue to

support his gambling habit.   The taxpayer’s lifestyle and

financial position indicated no accessions to wealth commensurate

with the amount of net gambling winnings determined by

respondent.   Finding it highly improbable that the taxpayer would
                               - 17 -

have purchased only winning tickets, the Court applied the rule

of Cohan v. Commissioner, 39 F.2d 540 (2d Cir. 1930), to estimate

the amount of the taxpayer’s gambling losses.

     Unlike Doffin v. Commissioner, supra, this is not a case

where the taxpayers had few assets, no income apart from

gambling, and no significant accessions to wealth during the year

at issue.    Petitioners have admitted to an increase in their net

worth for 1996 that corresponds roughly to the amount of

unreported gambling income that respondent has determined.

Petitioners introduced into evidence unaudited statements of

financial position, purporting to show the change in their net

worth during 1996.   These documents indicate that during 1996

petitioners’ net worth increased by $89,503 (from $542,275 to

$631,778).   These documents indicate that during 1996 petitioners

purchased, among other things, a new Chevrolet Suburban and a

motorcycle, and that the value of their interest in Mega

increased by some $70,000 during 1996.13   In short, we are unable

to conclude on the basis of the evidence in the record that

petitioners’ significant accessions to wealth in 1996 were not



     13
       Although petitioners testified that they did not put any
gambling winnings into Mega, we note that in 1996 Mega paid Laura
$24,000, even though she performed no services for Mega. In this
regard, Paula testified that Mega “paid my husband and I, since
we owned the company * * * they wrote us a check. But I didn’t
do anything.” These peculiar circumstances raise the suggestion,
if not the likelihood, that Mega’s assets and petitioners’
separate assets were to some degree fungible.
                                - 18 -

attributable in whole or part to their unreported gambling

winnings.

     Petitioners’ testimony on this score was less than

compelling.    On direct examination, Paula was asked the leading

question whether “you feel like your [1996] losses exceeded your

winnings”.    In response, Paula testified, “I think so.   I don’t

have–-we didn’t have any money. * * * I mean, it just–-I mean,

nothing really changed.    We had money in and out, in and out of–-

it was like we had gambling money all year.    It would go through

our fingers.”    Surely every taxpayer can attest that income has a

way of slipping through the fingers and leaving one feeling none

the richer for it.    This dolorous fact of life, however, affords

no basis for tax relief in the ordinary situation, much less in

the situation here involving unreported gambling winnings.

     In sum, we are unconvinced that petitioners’ gambling losses

exceeded the unreported gross gambling income not reflected in

the notice of deficiency.    The record provides no satisfactory

basis for estimating petitioners’ gambling losses in excess of

the amount we have allowed as a downward adjustment and the

amount conceded by respondent.    Consequently, we do not apply the

rule of Cohan v. Commissioner, supra, to estimate the amount of

losses.     See Donovan v. Commissioner, 359 F.2d 64 (1st Cir.

1966), affg. T.C. Memo. 1965-247; Stein v. Commissioner, 322 F.2d

78, 83 (5th Cir. 1963), affg. T.C. Memo. 1962-19; Schooler v.
                              - 19 -

Commissioner, supra; Mayer v. Commissioner, supra (disallowing

unsubstantiated slot machine losses).   Petitioners could have

avoided this result by keeping records of their gambling

activities or perhaps by simply using their Players’ Club cards

to track their slot machine play at the Casinos Magic.   Instead,

they spun the wheel with the tax laws and therein made a losing

wager.

     Accordingly, we allow petitioners no gambling losses for

1996, although, as previously discussed, we adjust downward (from

$91,000 to $86,705) respondent’s determination of petitioners’

unreported gross income from gambling, to account for

petitioners’ cost of making the winning slot machine bets at the

Casinos Magic.

Accuracy-Related Penalty

     Respondent determined that petitioners are liable for an

accuracy-related penalty under section 6662(a) for a substantial

understatement of tax.   Section 6662(a) imposes an accuracy-

related penalty equal to 20 percent of any underpayment that is

attributable to a substantial understatement of income tax.

Section 6662(d)(1) defines a “substantial understatement” of

income tax as one which exceeds the greater of 10 percent of the

tax required to be shown on the return or $5,000.   The accuracy-

related penalty does not apply with respect to any portion of the
                              - 20 -

underpayment if it is shown that the taxpayer had reasonable

cause and acted in good faith.   Sec. 6664(c).

     Because this court proceeding arises in connection with an

examination commenced after July 22, 1998, respondent bears the

burden of producing sufficient evidence to support imposition of

the accuracy-related penalty; however, the burden remains on

petitioners to show that the reasonable cause exception applies.

See sec. 7491(c); Higbee v. Commissioner, 116 T.C. 438, 446-447

(2001); Penn v. Commissioner, T.C. Memo. 2001-267.

     As previously discussed, the undisputed evidence shows that

petitioners had at least $86,705 in unreported gross income from

gambling, as determined by reference to the $91,000 of gambling

winnings as understated in the notice of deficiency.   Petitioners

have failed to substantiate gambling losses in excess of

unreported gambling gross income omitted from the notice of

deficiency.   The net result is a substantial understatement of

tax as defined in section 6662(d)(1)(A).

     In determining whether a taxpayer acted with reasonable

cause and in good faith, 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.   With respect to

petitioners’ 1996 gambling activities, four casinos issued

petitioners some 39 Forms W-2G, reporting aggregate gambling

winnings over $144,000–-an amount greater than petitioners’
                               - 21 -

substantial wage income.   Yet petitioners reported neither

gambling winnings nor gambling losses on their Federal income tax

return, nor did they disclose this omission on their return.

     On brief, petitioners argue that they are not liable for the

accuracy-related penalty because they believed their gambling

losses exceeded their gambling winnings and “in good faith with

reasonable cause under a wrong assumption did not report the

gambling winnings.”   It is well settled that taxpayers have a

duty to report as gross income gambling winnings such as those

involved here; gambling losses must be claimed as itemized

deductions, subject to statutory limitations.      See McClanahan v.

United States, 292 F.2d at 631-632; Gajewski v. Commissioner, 84

T.C. at 982; Johnston v. Commissioner, 25 T.C. 106, 108 (1955).

Taxpayers are required to take reasonable steps to determine the

law and comply with it.    Niedringhaus v. Commissioner, 99 T.C.

202, 222 (1992).   The record does not indicate that petitioners

took any such steps or that any portion of their underpayment was

due to reasonable cause.

     Accordingly, we conclude that petitioners are liable for an

 accuracy-related penalty under section 6662(a).

     To reflect the foregoing,

                                      Decision will be entered

                                 under Rule 155.
