T.C. Memo. 2007-110



                     UNITED STATES TAX COURT



            DANIEL AND KRISTEN PANICE, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 14819-04.           Filed April 30, 2007.



     Wendy S. Pearson, Terri A. Merriam, Jennifer A. Gellner,

Jaret R. Coles, and Asher B. Bearman, for petitioners.1

     Nhi T. Luu and Catherine Caballero, for respondent.




     1
       Wendy S. Pearson (Pearson), Terri A. Merriam (Merriam),
Jennifer A. Gellner (Gellner), and Jaret R. Coles entered their
appearances in this case by subscribing the petition commencing
this proceeding. See Rule 24(a). (Unless otherwise indicated,
Rule references are to the Tax Court Rules of Practice and
Procedure, and section references are to the applicable versions
of the Internal Revenue Code.) Asher B. Bearman entered his
appearance on July 18, 2005, and withdrew on Nov. 15, 2006.
Pearson and Gellner withdrew from the case on Oct. 24, 2006, and
Nov. 14, 2006, respectively.
                                 - 2 -

               MEMORANDUM FINDINGS OF FACT AND OPINION


     LARO, Judge:    This is an affected items proceeding arising

from a disallowed partnership loss claimed for 1992 by Timeshare

Breeding Service 1990-1, J.V. (TBS 90-1), a cattle partnership

organized, promoted, and operated by Walter J. Hoyt III (Hoyt).2

Petitioners participated in TBS 90-1, and they reported their

distributive share of its reported ordinary loss on their 1992

Federal income tax return.     With respect to their reporting of

the disallowed loss, respondent determined that petitioners are

liable for 1992 for a $205.80 accuracy-related penalty under

section 6662(a) and a $10,926.80 accuracy-related penalty under

section 6662(h).    Following petitioners’ concession that they are

liable for the accuracy-related penalty determined by respondent

under section 6662(a), we decide whether they are liable for the

accuracy-related penalty determined by respondent under section

6662(h).   We hold they are.

                          FINDINGS OF FACT

     The parties filed with the Court stipulations of fact and

accompanying exhibits.    The stipulated facts are found

accordingly.    Petitioners are husband and wife, and they resided

in Tinley Park, Illinois, when their petition was filed.


     2
       The Commissioner’s disallowance of this loss was upheld in
Durham Farms #1, J.V. v. Commissioner, T.C. Memo. 2000-159, affd.

(9th Cir. 2003).
                              - 3 -

     Petitioners began investing in TBS 90-1 in 1991.   That

partnership was subject to the unified audit and litigation

procedures of the Tax Equity and Fiscal Responsibility Act of

1982, Pub. L. 97-248, sec. 402(a), 96 Stat. 648.   Petitioners

filed their 1992 Federal income tax return on April 15, 1993, and

claimed thereon a deduction for a $112,996 ordinary loss passing

to them from TBS 90-1.

     In Durham Farms #1, J.V. v. Commissioner, T.C. Memo.

2000-159, affd. 

(9th Cir. 2003), the Court held

that TBS 90-1 was not entitled to deduct the loss claimed by

petitioners because TBS 90-1 did not receive the benefits and

burdens of ownership of the underlying asset (i.e., cattle).     The

decision in Durham Farms ordered and decided the following as to

TBS 90-1:

       Partnership Item           As Reported   As Determined

     Depreciation expense         $2,174,204         -0-
     Interest expense                137,750         -0-
     Accounting fees                   3,086         -0-
     Net Gain--Form 4797           5,435,510         -0-
     Net self-employment income   (2,315,040)        -0-
     Other farm deductions            -0-            -0-
     Guaranteed payments              -0-            -0-

The $2,315,040 of deductions underlying the adjustment to net

self-employment income consisted of depreciation expense equal to

93.916476605 percent of the total disallowed deductions, interest

expense equal to 5.950221162 percent of the total disallowed
                                - 4 -

deductions, and accounting expense equal to .13330232 percent of

the total disallowed deductions.

     Respondent determined that the decision in Durham Farms #1,

J.V. v. 

, increased petitioners’ 1992 ordinary

income by $113,879; i.e., the sum of a $112,996 increase to

reflect the adjustment to the ordinary income of TBS 90-1, plus

an $883 increase to reflect an adjustment to petitioners’

reported itemized deductions.   On May 13, 2002, respondent

reflected the $113,879 increase by assessing against petitioners

a $28,346 deficiency for 1992, as a computational adjustment

under section 6231(a)(6).   On May 19, 2004, respondent issued to

petitioners the relevant affected items notice of deficiency.

Respondent determined in the notice of deficiency that

93.916476605 percent of the $112,996 increase ($106,122) is

attributable to disallowed depreciation deduction claimed by TBS

90-1; that the tax upon the $106,122 ($27,317) is subject to the

40-percent penalty attributable to gross valuation misstatement

under section 6662(h); and that the remainder of the deficiency

($1,029; i.e., $28,346 - $27,317) is subject to the 20-percent

accuracy-related penalty attributable to negligence or disregard

of the rules or regulations.

     On April 17, 2006, the Court called this case for trial.

Petitioners were not present, and they did not present any
                                    - 5 -

evidence with the exception of stipulations of fact and

accompanying exhibits submitted therewith.

                                   OPINION

1.   Burden of Production

      Petitioners argue that section 7491(c) applies to place upon

respondent a burden of production as to the accuracy-related

penalty under section 6662(h).3       Section 7491(c) was added to the

Code by the Internal Revenue Service Restructuring and Reform Act

of 1998 (RRA), Pub. L. 105-206, sec. 3001(a), 112 Stat. 726,

effective for “court proceedings arising in connection with

examinations commencing after” July 22, 1998.       RRA sec.

3001(c)(1), 112 Stat. 727.     While the parties agree that the

Commissioner started examining TBS 90-1 before the effective date

of section 7491(c), the parties dispute whether the

Commissioner’s examination of TBS 90-1 is the relevant

      3
          Sec. 7491(c) provides:

           SEC. 7491(c). Penalties.--Notwithstanding any
      other provision of this title, the Secretary shall have
      the burden of production in any court proceeding with
      respect to the liability of any individual for any
      penalty, addition to tax, or additional amount imposed
      by this title.

In order to satisfy that burden of production, the record must
establish that it is appropriate to impose the relevant penalty,
addition to tax, or additional amount. See Higbee v.
Commissioner, 

, 446 (2001). The burden of production
and proof remain on the taxpayer to establish that the penalty,
addition to tax, or additional amount does not apply because of
reasonable cause, substantial authority, or the like. Id.; see
also H. Conf. Rept. 105-599, at 241 (1998), 1998-3 C.B. 747, 995.
                               - 6 -

examination for purposes of establishing the date on which the

Commissioner started his examination as to the affected items at

issue.   According to respondent, the affected items were

determined “in connection with” the examination of TBS 90-1 and,

hence, the date on which that examination began is the date that

is used to test whether section 7491(c) applies to this case.

According to petitioner, the Commissioner’s determination of the

affected items resulted from a separate, nonpartnership-level

examination of petitioners personally and, hence, the starting

date of the later examination is the date to be used to determine

the applicability of section 7491(c).

      Notwithstanding which party bears the burden of production

in this case, our review of the record leads us to the same

conclusion; i.e., that petitioners are liable for the section

6662(h) accuracy-related penalty for 1992 as determined by

respondent.   Accordingly, we need not and do not discuss any

further the parties’ dispute as to which of them bears the burden

of production in this case.   See McDonough v. Commissioner, T.C.

Memo. 2007-101.

2.   Overview of Sections 6662(h) and 6664

      Section 6662(h) provides that a taxpayer may be liable for a

40-percent penalty on any portion of an underpayment of tax

attributable to gross valuation misstatements.   No penalty is

imposed under that section, however, unless the portion exceeds
                                - 7 -

$5,000.   Sec. 6662(e)(2).   A gross valuation misstatement means

any substantial valuation misstatement, as determined under

section 6662(e), by substituting “400 percent” for “200 percent”.

Sec. 6662(h)(2)(A).   Pursuant to section 6662(e)(1)(A), as read

without the referenced substitution of text, a substantial

valuation misstatement occurs if “the value of any property (or

the adjusted basis of any property) claimed on any return * * *

is 200 percent or more of the amount determined to be the correct

amount of such valuation or adjusted basis”.   After the

referenced substitution of text, a gross valuation misstatement

occurs when the value or basis claimed on a return is 400 percent

or more of the correct value or basis.

     No penalty is imposed under section 6662(h), however, to the

extent that the taxpayer had reasonable cause for the

underpayment of tax and acted in good faith with respect to the

underpayment.   Sec. 6664(c)(1); see also Hansen v. Commissioner,

, 1029 (9th Cir. 2006), affg. T.C. Memo. 2004-269.

The determination of whether a taxpayer acted with reasonable

cause and in good faith is made on a case-by-case basis, taking

into account all pertinent facts and circumstances.    Sec.

1.6664-4(b)(1), Income Tax Regs.; see also Hansen v.

at 1028-1029.    The extent of the taxpayer’s

efforts to ascertain his proper tax liability is generally the
                                - 8 -

most important factor.    Sec. 1.6664-4(b)(1), Income Tax Regs.;

see also Hansen v. 

at 1028-1029.

      Reasonable cause and good faith under section 6664(c) may be

established where there is an honest misunderstanding of fact or

law that is reasonable in light of all facts and circumstances,

including the experience, knowledge, and education of the

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

cause and good faith are not necessarily established by reliance

on facts that, unknown to the taxpayer, are incorrect.

  Applicability of Sections 6662(h) and 6664

      In Durham Farms #1, J.V. v. Commissioner, T.C. Memo.

2000-159, the Court held that TBS 90-1 did not receive the

benefits and burdens of ownership of the cattle in dispute there

and was not entitled to partnership deductions and losses claimed

with respect thereto.    The Court’s decision stated that the

partnership’s “Depreciation Expense”, which was reported as

$2,174,204, was zero.    The disallowance of that item resulted in

a computational adjustment (and tax understatement) for 1992, and

a corresponding assessment against petitioners, of $28,346.

Because petitioners’ adjusted basis for the depreciation expense

deduction also was zero, the underpayment for 1992 resulting from

the disallowance of petitioners’ share of the partnership loss

from TBS 90-1, most of which was attributable to a disallowed

depreciation expense, is attributable to an overstatement of
                                 - 9 -

bases of more than 400 percent of the amount determined to be the

correct adjusted bases.     Keller v. Commissioner, T.C. Memo. 2006-

131; Jaroff v. Commissioner, T.C. Memo. 2004-276; see Zirker v.

Commissioner, 

(1986); see also McDonough v.

.     In that petitioners’ resulting underpayment

of tax for 1992 exceeded $5,000, we conclude that their

underpayment of 1992 tax resulting from the disallowance of their

reported cost bases and depreciation deduction was attributable

to a gross valuation misstatement of over $5,000.     Massengill v.

Commissioner, 

(8th Cir. 1989), affg. T.C. Memo.

1988-427; Zirker v. 

; Jaroff v. 

; see also McDonough v. 

.     We thus also

conclude that petitioners are liable for the 40-percent accuracy-

related penalty under section 6662(h) for 1992, unless they meet

the section 6664(c) exception for reasonable cause and good

faith.

     Petitioners’ posttrial briefs argue that (among other cases)

Gainer v. Commissioner, 

(9th Cir. 1990), affg. T.C.

Memo. 1988-416, and Todd v. Commissioner, 

(5th Cir.

1988), affg. 

(1987), establish that the accuracy-

related penalty under section 6662(h) cannot apply if an asset

such as the cattle at issue fail to exist.    We disagree with

petitioner’s argument.    The deductions in the two cited cases

relied upon by petitioners were disallowed because the relevant
                              - 10 -

assets existed but were not placed in service during the years

that were the subject of those cases; the disallowance did not

result from an asset’s valuation or basis.   Here, valuation or

basis was a deciding factor in determining whether TBS 90-1 was

entitled to depreciation expense and other deductions claimed

with respect to the cattle.   Moreover, as we stated in Keller v.

, in rejecting an argument similar to that of

petitioners:

           If we accept petitioner’s assertion that he never
      received the benefits and burdens of ownership of the
      cattle, or that the cattle never existed, then his
      bases in the cattle would be zero. See Zirker v.
      Commissioner, 

, 978-979 (1986) (finding that
      no actual sale of cattle took place and the correct
      adjusted basis of cattle was zero); Massengill v.
      Commissioner, T.C. Memo. 1988-427 (same as Zirker),
      affd. 

(8th Cir. 1989). This conclusion is
      supported by petitioner’s concession that he was not
      entitled to cost basis or depreciation deductions. If
      petitioner’s correct bases are zero, then the bases
      claimed on his returns are considered to be 400 percent
      or more of the correct amount, and are thus gross
      valuation misstatements. See sec. 1.6662-5(g), Income
      Tax Regs.; see also Zirker v. 

at
      978-979.[4]

4.   Claimed Defense to the Accuracy-Related Penalty

      We understand petitioners to argue that their underpayment

of tax for 1992 resulted from an honest mistake of fact.    In

support thereof, petitioners discuss the case of Bales v.


      4
       Petitioners argue that the Court may sustain respondent’s
determination only if respondent establishes that some cattle
existed and the value of that cattle. We disagree for the
reasons stated in this quotation and elsewhere in this paragraph.
                              - 11 -

Commissioner, T.C. Memo. 1989-568.     We disagree with petitioners

that they had any such misunderstanding of fact sufficient to be

a defense to the accuracy-related penalty under section 6662(h).

In addition to the fact that the record is devoid of any evidence

establishing that petitioners relied on Bales in investing in

TBS 90-1 and claiming the purported loss for 1992 flowing

therefrom, the case of Bales involved different participants,

different partnerships, and different years.    See Hansen v.

; Mortensen v. Commissioner,

, 391-392 (6th Cir. 2006), affg. T.C. Memo. 2004-279;

Sanders v. Commissioner, T.C. Memo. 2005-163.

5.   Conclusion

      We conclude that petitioners are liable for the section

6662(h) accuracy-related penalty for 1992, as determined by

respondent.   See McDonough v. Commissioner, T.C. Memo. 2007-101.

We have considered all arguments made by petitioners for a

contrary holding, and we conclude that any argument not discussed

herein is either irrelevant or without merit.


                                           An appropriate order and

                                     decision will be entered.