                         T.C. Memo. 1996-327



                       UNITED STATES TAX COURT



         PHILIP H. FRIEDMAN AND ANNA FRIEDMAN, Petitioners v.
             COMMISSIONER OF INTERNAL REVENUE, Respondent*



     Docket No. 7359-90.                         Filed July 17, 1996.



     Jay J. Freireich, for petitioners.

     Susan G. Lewis, for respondent.



                   SUPPLEMENTAL MEMORANDUM OPINION

     GERBER, Judge:    This case has been the subject of four prior

opinions of this Court,1 the last of which held that Anna

     *
       This opinion supplements a previously released opinion:
Friedman v. Commissioner, T.C. Memo. 1995-576.
     1
       Friedman v. Commissioner, 97 T.C. 606 (1991), concerning
whether "grossly erroneous items", within the meaning of sec.
6013(e)(1)(B), could have been contained on a refund claim, Form
                                                   (continued...)
                               - 2 -

Friedman (petitioner) was an innocent spouse within the meaning

of section 6013(e).2   The parties' current controversy involves

their conflicting Rule 155 tax computations.

     Initially, we found that petitioner was not entitled to

innocent spouse relief with respect to two items.    Concerning the

capital loss carryover, we found it was not a grossly erroneous

item and that it did not meet the section 6013(e) requirements.

The U.S. Court of Appeals for the Second Circuit affirmed that

holding.   Regarding losses from a computer leasing transaction,

we found the deductions of those losses to be grossly erroneous

items.   However, we also found that petitioner failed to meet the

requirement that she did not know, or have reason to know, that

the deductions would give rise to substantial understatements

when she signed the returns.   Sec. 6013(e)(1)(C).   The Court of

Appeals reversed our finding on whether petitioner knew or had

     1
      (...continued)
1045, rather than on the Form 1040; Friedman v. Commissioner,
T.C. Memo. 1992-89, concerning whether the testimony of an expert
witness could be offered to show whether one of petitioners was a
truthful witness; Friedman v. Commissioner, T.C. Memo. 1993-549,
affd. in part, revd. and remanded in part 53 F.3d 523 (2d Cir.
1995), which concerned whether Anna Friedman was an innocent
spouse within the meaning of sec. 6013(e); and Friedman v.
Commissioner, T.C. Memo. 1995-576, where we held that Anna
Friedman was an innocent spouse with respect to a grossly
erroneous item in accord with the judgment and remand of the
Court of Appeals and made findings concerning whether it was
equitable to hold her liable.
     2
       All section references are to the Internal Revenue Code
in effect for the taxable period under consideration, and all
Rule references are to this Court's Rules of Practice and
Procedure, unless otherwise indicated.
                               - 3 -

reason to know and remanded the matter for our consideration of

whether it would be equitable to hold her liable with respect to

the grossly erroneous leasing transaction deductions.   Friedman

v. Commissioner, 53 F.3d 523 (2d Cir. 1995), affg. in part and

revg. and remanding in part T.C. Memo. 1993-549.

     This case involves 5 taxable years, and the losses claimed

for the leasing transaction occur in all years, whereas the

capital loss item occurs in only one year, 1983.   The parties'

computations agree with respect to the 1981, 1982, 1984, and 1985

tax years; i.e., petitioner would be relieved of income tax

liability and all additions to tax because the leasing loss was

the sole adjustment.   With respect to 1983, petitioner reaches

the same result as in the other 4 years (no liability), and

respondent computes a $53,307.36 income tax liability and

additions to tax in the amounts of $47,640.233 and $13,326.84

under sections 6653(a) and 6661, respectively.   This opinion

addresses the parties' differing approaches to the Rule 155

computation.




     3
       For 1983, the sec. 6653(a)(1) addition to tax set forth in
the notice of deficiency was $5,982.24, without considering sec.
6653(a)(2), which provided for 50 percent of the interest due on
the underpayment. At the time of assessment (Mar. 28, 1994),
following the entry of decision based on T.C. Memo. 1993-549, the
addition to tax had increased to $106,925.26, including the 50-
percent interest addition. After proposed abatement for the
portion not attributable to the capital loss, the sec. 6653(a)(1)
and (2) addition amounts to $47,640.23.
                                - 4 -

     By way of background, petitioners claimed but, in

substantial part, did not use a $327,600 net short-term capital

loss on their 1980 joint income tax return.   Accordingly,

petitioners claimed a $322,340 short-term capital loss carryover

from the 1980 tax year on their 1983 tax return.   Respondent, in

the statutory notice of deficiency for 1983, allowed $55,803 of

this loss carryover.   The balance of the loss was allowed for the

1980 taxable year pursuant to an audit examination of the 1980

tax year.    In Friedman v. Commissioner, T.C. Memo. 1993-549, we

held:

          With respect to the capital loss carryover, at the
     time petitioners filed their 1983 return, the 1980
     return had not been audited. Therefore, when the 1983
     return was filed with the capital loss carryover,
     petitioners did not know that the carryover duplicated
     losses [subsequently] allowed in 1980. The later
     disallowance was purely mechanical and a natural result
     of an adjustment to a prior year's return. The
     deduction was not frivolous or fraudulent. Therefore,
     the deduction had a basis in fact or law and the
     deduction is not grossly erroneous.

     Under Rule 155, parties are required to submit "computations

pursuant to the Court's determination of the issues, showing the

correct amount of the deficiency * * * to be entered as the

decision."   Parties are not permitted to raise new issues or

matters in connection with the Rule 155 computations.     Bankers

Pocahontas Coal Co. v. Burnet, 287 U.S. 308 (1932).     The starting

point for the computation is the statutory notice of deficiency

from which the parties compute the redetermined deficiency based
                               - 5 -

upon matters agreed by the parties or ruled upon by the Court.

Home Group, Inc. v. Commissioner, 91 T.C. 265, 269 (1988), affd.

875 F.2d 377 (2d Cir. 1989); Whitham v. Commissioner, a

Memorandum Opinion of this Court dated Jan. 30, 1953.

     The starting point for each party's computation of the 1983

tax liability here is the $178,782 taxable income per the notice

of deficiency.   Petitioner then proceeds to deduct the $900,525

loss attributable to the grossly erroneous item, which results in

"negative" taxable income of $729,5904 after considering the

income per the notice of deficiency.   Petitioner contends that

the negative taxable income obviates the possibility of the

capital loss item causing any taxable income.

     Respondent computes her 1983 proposed tax deficiency for

petitioner in accord with the following pertinent instructions in

subsection 45(11)(20) (Guidelines for Applying "Innocent Spouse"

Provisions), 4 Examination, Internal Revenue Manual (CCH):

          (7) * * * If it is proposed to hold both spouses
     liable, but not to the same extent, in respect of the
     total deficiency, two computations * * * will be
     required. First, a computation of the total
     deficiency, including any applicable penalties should
     be made, without taking into consideration the innocent
     spouse provisions. Next, a separate computation of the
     liability, including penalties, of the non-culpable
     spouse. This computation will start with the total
     corrected taxable income without regard to the innocent
     spouse provisions and will eliminate therefrom the
     adjustments for which relief is provided under such

     4
       In addition to the $900,525 claimed loss, two self-
operating mathematical items are also considered--a $8,147
reduction for "medical" and a $300 increase for "contributions".
                                 - 6 -

     public law. This latter computation arrives at the
     amount of the liability which is considered joint. The
     difference between such joint liability and the total
     deficiency will constitute the separate liability of
     the culpable spouse. * * *

     It is noted that respondent's manual provisions have no

binding effect on petitioner or the Court.    See, e.g., Zimmerman

v. Commissioner, 71 T.C. 367, 371 (1978), and cases cited

therein, affd. without published opinion 614 F.2d 1294 (2d Cir.

1979) (involving the lack of effect of a taxpayer's reliance upon

a tax guide issued by the Commissioner).     Petitioner, however,

agrees with respondent that the above-quoted manual provisions

"[set] forth how the computation should be made."

     Petitioner agrees with respondent that the first step is to

begin with the notice of deficiency computation of the income tax

deficiency and additions to tax.    Petitioner also agrees that the

next step is to compute the separate liability of the so-called

nonculpable or innocent spouse, which, according to the manual

provisions, is the portion of the liability that is considered

joint.    And, finally, the difference between the joint liability

and the total liability constitutes the individual liability of

the so-called culpable spouse.

     The core of petitioner's disagreement with respondent is the

computation of the liability of the innocent spouse, which is

also the portion of the liability that is joint.5    Petitioner

     5
         Petitioner does not allege that respondent's mathematical
                                                     (continued...)
                                - 7 -

directs us to a specific portion of the manual provisions, as

follows:

     This computation will start with the total corrected
     taxable income without regard to the innocent spouse
     provisions and will eliminate therefrom the adjustments
     for which relief is provided under such public law.
     * * *

Petitioner contends that the elimination of the grossly erroneous

leasing transaction is tantamount to permitting the deduction to

the innocent spouse.    Respondent treats the elimination language

as disregarding the grossly erroneous leasing transaction so as

not to charge petitioner, the innocent spouse, with income from

the disallowance of the claimed loss.    Respondent goes on to

compute the effect of the disallowance of the short-term capital

loss carryover, which is not an item for which innocent spouse

relief was granted.    In that manner, respondent arrives at a

portion of the 1983 tax liability for which Mr. Friedman (the

"culpable" spouse) and Mrs. Friedman (the "nonculpable" spouse)

are both liable.   That joint liability is then subtracted from

the liability determined in the notice of deficiency, resulting

in the portion of the liability for which only Mr. Friedman (the

"culpable" spouse) is liable.    We agree with respondent's

approach and interpretation.




     5
      (...continued)
computation is in error. Petitioner's attack is one that
concerns only theory or approach.
                                - 8 -

     To understand the dynamics of the disagreement, we must

consider some of the items reported on the 1983 Federal income

tax return and the adjustments made to that return in the notice

of deficiency.   The return contained three significant items of

income:   $100,000 of wages, $122,356 of capital gain, and $19,912

of rents or royalities.    The capital gain reported was a netted

and reduced amount composed of a net long-term capital gain of

$656,139 reduced by the $322,340 short-term capital loss

carryover from 1980 and a $27,908 long-term capital loss, to

arrive at $305,891, 40 percent of which ($122,356) was carried

from Schedule D to page 1 of the return.

     Accordingly, without considering the leasing transaction

loss ($900,5256), approximately $242,000 of income was reported

on page 1 of the 1983 return.   Respondent, in the notice of

deficiency, allowed $55,803 of the short-term capital loss

carryover due to the fact that $271,800 had been used for the

1980 year.   Respondent's determination resulted in $228,971.20 of

capital gain income instead of the $122,356 reported, or an

increase of $106,615.20.   The $106,615.20 increase is the number

on which respondent based the Rule 155 computation of

petitioner's $53,307.36 income tax liability.   Comparing the

$53,307.36 and the $119,644.76 deficiency set forth in the notice

of deficiency reveals the dichotomy between the portion of the

     6
       The loss was reduced by $2,227 of miscellaneous income for
a net amount of $898,298.
                                - 9 -

income tax liability that is joint and the portion from which

petitioner has been relieved.

     Section 6013(e)(1), for the tax years in issue, is expressed

in terms of relief from liability for tax "to the extent such

liability is attributable to such omission from gross income [of

tax attributable to grossly erroneous items of one spouse]."7

The benefit of section 6013(e) is provided in the form of relief

from tax, not by permitting the innocent spouse to have the

benefit of a "grossly erroneous" deduction.    Petitioner's relief

from the grossly erroneous leasing transaction losses is,

accordingly, limited to not subjecting her to tax liability

attributable to the disallowance of the loss.    Petitioner was not

an innocent spouse as to the short-term capital loss

disallowance.   Accordingly, she would be liable, along with Mr.

Friedman, for the portion of the liability attributable to the

disallowed portion of the short-term capital loss item.

     The "eliminate therefrom" language of respondent's manual

addresses relief from tax liability attributable to a grossly

erroneous item.   The manual language appears to be designed to

deal with grossly erroneous items attributed to either omitted

income or claim of a deduction, the disallowance of which

generates additional income.    If computation of the joint


     7
       Later versions of sec. 6013(e)(1) have the phrase
"substantial understatement" as a replacement for the phrase
"omission from gross income".
                             - 10 -

liability results in zero joint liability, then petitioner (the

innocent spouse) would be the recipient of a windfall in the form

of relief from the portion of the income tax liability

attributable to the short-term capital loss disallowance--relief

that was not intended by section 6013(e).

     To reflect the foregoing,

                                      Decision will be entered in

                                 the amounts proposed in

                                 respondent's computation.
