                        T.C. Memo. 2006-83



                      UNITED STATES TAX COURT



         LARRY G. BANGS AND MARY L. BANGS, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 17415-04.            Filed April 24, 2006.



     W. Alan Lautanen, for petitioners.

     Erin K. Huss, for respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     KROUPA, Judge:   Respondent determined deficiencies in

petitioners’ Federal income taxes and accuracy-related penalties

under section 6662(a)1 for 1999, 2000, 2001, and 2002 (the years

at issue).   For 1999, respondent determined a $14,335 deficiency

and determined that petitioners were liable for a $2,867

     1
      All section references are to the Internal Revenue Code for
the years at issue, and all Rule references are to the Tax Court
Rules of Practice and Procedure, unless otherwise indicated.
                                -2-

accuracy-related penalty.   For 2000, respondent determined an

$11,159 deficiency and determined that petitioners were liable

for a $2,231 accuracy-related penalty.   For 2001, respondent

determined a $7,605 deficiency and determined that petitioners

were liable for a $1,521 accuracy-related penalty.   For 2002,

respondent determined an $11,413 deficiency and determined that

petitioners were liable for a $2,282 accuracy-related penalty.

     After concessions, there are three issues for decision.     The

first issue is whether petitioners engaged in their lemon farming

activity for profit.   We hold they did not.2

     The second issue is whether petitioners are liable for taxes

on interest and capital gains they admit they earned during the

years at issue but which were erroneously omitted on the Form

4549A, Income Tax Examination Changes, petitioners signed.      We

hold petitioners are liable for the taxes on the interest and

capital gains.

     The third issue is whether petitioners are liable for the

accuracy-related penalty.   We hold they are liable for the

accuracy-related penalty except with respect to the portion of

the understatement attributable to the lemon farming activity.




     2
      If we had found petitioners engaged in their lemon farming
activity for profit, we would have then been asked to consider
whether petitioners should have capitalized, rather than
deducted, their expenses relating to their lemon farming
activity. Because of our holding on the for profit issue, we
need not address the capitalization issue under sec. 263A.
                                 -3-

                           FINDINGS OF FACT

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

The stipulation of facts, the supplemental stipulation of facts,

and the accompanying exhibits are incorporated by this reference.

Petitioners resided in California at the time they filed the

petition in this case.

Petitioners

     Petitioner Larry Bangs (Mr. Bangs) was raised and met his

future wife in a small farming town in Kansas.    Mr. Bangs and his

future wife decided to move to California in 1964 to seek warmer

weather after Mr. Bangs spent some time in college and worked in

the salt mines.    They were then married.3

     Mr. Bangs accepted a job at Standard Oil in California.    He

started in a plant and then moved to the sales department, where

he sold polyester resin for 6 years.    His sales experience and

entrepreneurial drive convinced him to start a new business with

his wife.    They began their own business distributing fiberglass

products.    The business was successful and grew into fiberglass

manufacturing as well.    Petitioners explored several different

business opportunities, some of which were successful.

Petitioners found success in manufacturing plastic lettering,

manufacturing chemical tanks, and designing the curled tail on

the back of skateboards.    Petitioners lost money in jet ski

manufacturing, however, and they discontinued it when it was not



     3
         We refer to petitioner Mary Bangs as Mrs. Bangs.
                                  -4-

profitable.    Petitioners eventually sold the fiberglass business

for several million dollars in the early 1980s.

     Petitioners considered themselves retired after they sold

their fiberglass business, when Mr. Bangs was approximately 40

years old.    Petitioners owned several rental properties during

the years at issue that generated between $400,000 and $500,000

annually in gross income.

The Farming Activity

     Petitioners purchased 40 acres of land in California’s

Valley Center area in 1971.    They had been looking for property

for some time and were able to obtain this property at a good

price.   When petitioners sold their fiberglass business in the

early 1980s, they decided to build a 6,000 square foot house on

the Valley Center property.    Mr. Bangs hoped to get back to

farming and was looking for something he could do in his backyard

when he was 70 and retired.    Petitioners had fond memories of

farming from their youth and were interested in learning whether

it was possible to replicate their experiences in California.

     Petitioners spoke to an agricultural adviser and asked what

type of crop could be grown on the land.    This expert advised

petitioners to grow lemons because they were fairly hardy and

could thrive with little water.    Mr. Bangs also learned that

lemon trees had a long life.

     Petitioners planted some lemon trees on their property in

the early 1990s.    The record is unclear, however, how many trees

were planted.    Petitioners also made some improvements to their
                                 -5-

property.    They built a warehouse, a ripening room, and added

water pumps.    Petitioners also had a large well on the property

that was producing more water than necessary for the lemon trees,

so petitioners also decided to raise catfish.    They watered the

lemon trees with refuse or runoff water from the catfish tanks,

but when the catfish venture was unsuccessful, petitioners

abandoned it.

     Mr. Bangs decided in 1994 to harvest some lemons.    He

decided to harvest less than 4 years after planting the trees

even though he was aware that it would take 10 years before the

trees would fully produce.    He also knew that it might stunt the

growth of the trees but he was anxious to see how the lemon

market worked.    Petitioners sold these lemons to a packing house

in Rancho Santa Fe and reported $469 of income from lemon sales

in 1994.

      Mr. Bangs claimed that he spent 60 to 80 hours per week on

the lemon farming activity, and claimed that petitioners together

spent between 80 to 90 hours per week on the activity.    Mr. Bangs

pruned and weeded the tree area, repaired equipment, and did

other activities.    Mrs. Bangs did both physical work and kept the

financial records.    Petitioners did not employ any outside

employees.

     Mrs. Bangs was responsible for the financial records of the

farming activity.    The only financial records for the activity,

however, consisted of stacks of receipts.    Petitioners did not
                                 -6-

have a business plan, a separate bank account, nor any books and

records in which income and expenses were recorded.

     Petitioners reported income, expenses, and gain or loss on

Schedule F, Profit or Loss from Farming, to their income tax

returns for 1993 through 2002 as follows:

         Year        Income            Expenses       Gain (Loss)
         1993          --              $47,687        $(47,687)
         1994         $469              63,699         (63,230)
         1995        1,343              43,952         (42,609)
         1996        1,341              37,484         (36,143)
         1997        2,728              39,922         (37,194)
                       1
         1998              556          35,278         (34,722)
         19992         --               28,935          (28,935)
         20003         --               37,853          (37,853)
         2001          --               16,591          (16,591)
         2002          --               33,535          (33,535)
     1
       While the Schedules F for 1995 through 1998 indicate that
petitioners earned some income from farming during these years,
there is no indication that this income was from lemon sales, nor
did petitioners introduce receipts from lemon purchasers as they
did for the 1994 income.
     2
       The amounts reported here for 1999, 2000, and 2001 are
from petitioners’ pro forma returns, not petitioners’ original
individual income tax returns. Petitioners’ original 1999 return
reported a portion of this loss, and the record reflects that the
remainder of this loss was reported on a trust return. See
infra, pp. 7-8.
     3
       Petitioners' original returns for 2000 and 2001 did not
reflect any lemon farming activity because petitioners included
it on a trust return for those years. The income, expenses, and
losses for 2000 and 2001 were included on the pro forma returns.

The income petitioners reported in 1994 through 1998 was

insufficient to cover the property taxes.
                                -7-

     Respondent audited petitioners’ return for 1995.    In that

audit, respondent did not disallow the deductions petitioners

claimed in connection with their farming activity for that year.

     Several natural events occurred during the years at issue

that impacted the lemon farming activity.    A 1993 wildfire

destroyed some of the lemon trees.    Poor soil conditions led

petitioners to consult a supervising plant pathologist in 1997

out of concern for their trees’ health.    The pathologist examined

the trees and noted that they looked unhealthy and had curled

yellow leaves.   The pathologist reported that these problems

could be due to the soil staying wet too long or to a mineral

deficiency.   Petitioners also claim they experienced a water

shortage during the years at issue.    Petitioners drilled

additional wells in 2000 and 2002, but their efforts did not

produce any additional water.   Mr. Bangs indicated at trial that

he would await the outcome of this case before he decided whether

to drill more wells on the property.

The Trust Scheme

     Petitioners became involved in a trust scheme in 1999.

They did not consult an attorney or CPA before they bought into

the scheme.   Petitioners transferred title to most of their

assets to trusts to avoid paying taxes on the income from these

assets.   Petitioners, in contrast to the lack of records for

lemon farming, kept detailed books and records relating to their

trusts.   The trust-related financial records included balance

sheets, capital gain reports, and transaction reports by
                                 -8-

category.   There was no record of the lemon farming activity in

any of the trust records, but detailed records of petitioners’

investment and rental activities were included in the trust

records.    Losses from the lemon farming activity were deducted on

a trust return for at least 1999 and 2000, however.

     On audit, the revenue agent informed petitioners that the

trusts would be collapsed.    Petitioners decided to hire a CPA to

prepare pro forma returns so petitioners would be better prepared

to settle with respondent.    The pro forma returns aggregated the

amounts reported on the trust returns and the amounts reported on

individual returns for the years at issue.   Petitioners and the

revenue agent were unable, however, to resolve the lemon farming

activity issues.

     During the course of the audit, respondent’s revenue agent

asked to tour the property.   Petitioners would not permit the

revenue agent to tour the property and would not answer questions

about their farming activity.   Respondent issued a summons to

petitioners to permit the revenue agent to tour petitioners’

property.   When the revenue agent was finally permitted to visit

the property, she noted that the trees did not look healthy and

that some were dead.   She also noted that the trees on the

property across from petitioners’ property, on the other hand,

were healthy and thriving.    The revenue agent also noticed that

petitioners were storing yard items in the ripening room and the

warehouse storage held several classic cars in various stages of

repair.
                                  -9-

     Respondent’s revenue agent sent petitioners a number of

documents in September 2003 to resolve all non-farming activity

issues after she reviewed petitioners’ pro forma returns.   These

documents included Form 4549A, Form 870, Waiver of Restrictions

on Assessment, Form 906, Closing Agreement Covering Specific

Matters (the closing agreement), and Form 872, Consent to Extend

the Time to Assess Tax.   Petitioners needed to extend the period

of limitations because the period for 1999 would soon expire.

     The closing agreement resolved the dispute relating to the

proper treatment of the trusts.    In it, the parties agreed that

the trusts would be disregarded and the trusts were petitioners’

alter egos.   Petitioners also agreed that they would report on

individual returns for 1999 and subsequent years all income,

expenses, and deductions, as allowed by the Code.   In addition,

the parties agreed that petitioners would be liable for

additional taxes, penalties, and interest on their individual

returns due to collapsing the trusts.

     Petitioners signed each document and returned them to the

revenue agent.   Respondent also executed the closing agreement.

Shortly after petitioners signed these documents, the revenue

agent discovered that she had made errors in the Form 4549A

petitioners signed.   The revenue agent had inadvertently omitted

interest income that petitioners had shown on their pro forma

returns, and she miscalculated the amount of capital gains.

Petitioners apparently did not notice these mistakes when they
                                 -10-

executed the documents.     The revenue agent sent petitioners a

corrected Form 4549A, which petitioners refused to sign.

     Respondent mailed a deficiency notice to petitioners on June

18, 2004, in which respondent computed the deficiency amounts

from the original returns petitioners filed for the years at

issue.   Petitioners timely filed a petition with this Court

contesting respondent’s disallowance of the lemon farming

expenses for 1999 and 20024 and asserting that petitioners were

entitled to additional deductions for lemon farming expenses in

2000 and 2001.5   Petitioners are also contesting the treatment of

the interest and capital gains and the imposition of the

accuracy-related penalty.




     4
      It appears from the record that a portion of the losses
from the lemon farming activity was reported on petitioners’
individual returns for 1999 and a portion of the losses were
reported on a trust return for that year.
     5
      Respondent disallowed the lemon farming expenses for 1999
and 2002 in the deficiency notice, but the lemon farming expenses
for 2000 and 2001 were not reported on petitioners’ original
returns. Respondent did not disallow the lemon farming expenses
for 2000 and 2001 in the deficiency notice because respondent
computed the deficiencies from the original returns petitioners
filed. Petitioners deducted the lemon farming expenses on a
trust return for 2000, and we assume petitioners also deducted
them on a trust return for 2001, although the record is not
clear. Petitioners assert in their petition that they are
entitled to additional deductions for 2000 and 2001 for their
lemon farming activity that were unreported on their original
returns. Petitioners’ assertion in their petition is consistent
with petitioners’ position on their pro forma returns, which do
include deductions for lemon farming expenses for all years.
                               -11-

                              OPINION

     There are several issues for decision.   We are asked to

decide, first, whether petitioners engaged in their lemon farming

activity for profit.   We are also asked to decide whether

petitioners are liable for taxes on interest income and capital

gains that petitioners admit they earned for the years at issue,

but were excluded from the initial Form 4549A petitioners signed.

Finally, we must decide whether petitioners are liable for the

accuracy-related penalty for each of the years at issue.     We

address each of these issues in turn, after first considering the

burden of proof.

I.   Burden of Proof

     In general, the Commissioner’s determinations in the

deficiency notice are presumed correct, and the taxpayer bears

the burden of proving that the Commissioner’s determinations are

in error.   See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115

(1933).   Section 7491(a) shifts the burden of proof to the

Commissioner with respect to a factual issue relevant to a

taxpayer’s liability for tax, however, under certain

circumstances.   The burden shifts to the Commissioner if the

taxpayer introduces credible evidence with respect to the issue,

complies with substantiation requirements, maintains all required

records, and cooperates with the Commissioner’s reasonable
                                -12-

requests for witnesses, information, documents, meetings, and

interviews.   Sec. 7491(a)(2)(A) and (B).6

      We find that petitioners failed to comply with respondent’s

reasonable requests.   Id.   Although petitioners produced

documents respondent requested, petitioners refused to answer

respondent’s questions about their farming activity.    Respondent

was forced to issue petitioners a summons to obtain necessary

information to complete the audit.     Accordingly, we find that the

burden of proof remains with petitioners.

II.   Whether Petitioners Engaged in Their Lemon Farming Activity
      for Profit

      A.   Section 183 Generally

      We now address whether petitioners engaged in their lemon

farming activity for profit within the meaning of section 183

during the years at issue.   Section 183(a) provides generally

that if an individual engages in an activity and “if such

activity is not engaged in for profit, no deduction attributable

to such activity shall be allowed under this chapter except as

provided in this section.”   Deductions that would be allowable

without regard to whether the activity is engaged in for profit

are allowed under section 183(b)(1).    Deductions that would be

allowable only if the activity were engaged in for profit are

allowed under section 183(b)(2), but only to the extent that the


      6
      Sec. 7491 is effective with respect to court proceedings
arising in connection with examinations by the Commissioner
commencing after July 22, 1998, the date of enactment of the
Internal Revenue Service Restructuring and Reform Act of 1998,
Pub. L. 105-206, sec. 3001(a), 112 Stat. 726.
                                -13-

gross income from the activity exceeds the deductions allowable

under section 183(b)(1).

     We follow the Court of Appeals opinion squarely in point

when appeal from our decision would lie to that court absent

stipulation by the parties to the contrary.    Golsen v.

Commissioner, 54 T.C. 742 (1970), affd. 445 F.2d 985 (10th Cir.

1971).    Taxpayers residing in the Ninth Circuit, such as

petitioners, must prove they conducted their activities with the

primary, predominant, or principal purpose of realizing an

economic profit independent of tax savings.    See Wolf v.

Commissioner, 4 F.3d 709, 713 (9th Cir. 1993), affg T.C. Memo.

1991-212; Polakof v. Commissioner, 820 F.2d 321, 323 (9th Cir.

1987), affg. T.C. Memo. 1985-197; Indep. Elec. Supply, Inc. v.

Commissioner, 781 F.2d 724, 726 (9th Cir. 1986), affg. Lahr v.

Commissioner, T.C. Memo. 1984-472.

     Whether a taxpayer has the primary, predominant, or

principal purpose of realizing an economic profit independent of

tax savings is determined on the basis of all surrounding facts

and circumstances.    Polakof v. Commissioner, supra at 324; Indep.
Elec. Supply, Inc. v. Commissioner, supra at 727; Dreicer v.

Commissioner, 78 T.C. 642, 645 (1982), affd. without published

opinion 702 F.2d 1205 (D.C. Cir. 1983); sec. 1.183-2(b), Income

Tax Regs.    While a taxpayer’s expectation of profit need not be

reasonable, there must be a good faith objective of making a

profit.    Allen v. Commissioner, 72 T.C. 28, 33 (1979); sec.

1.183-2(a), Income Tax Regs.
                                 -14-

     B.      Nine Factors

     We structure our analysis around nine nonexclusive factors.

Sec. 1.183-2(b), Income Tax Regs.       The nine factors are:   (1) The

manner in which the taxpayer carried on the activity; (2) the

expertise of the taxpayer or his or her advisers; (3) the time

and effort expended by the taxpayer in carrying on the activity;

(4) the expectation that the assets used in the activity may

appreciate in value; (5) the success of the taxpayer in carrying

on other similar or dissimilar activities; (6) the taxpayer’s

history of income or loss with respect to the activity; (7) the

amount of occasional profits, if any, which are earned; (8) the

financial status of the taxpayer; and (9) whether elements of

personal pleasure or recreation are involved.       Id.

     No factor or set of factors is controlling, nor is the

existence of a majority of factors favoring or disfavoring a

profit objective necessarily controlling.       Hendricks v.

Commissioner, 32 F.3d 94, 98 (4th Cir. 1994), affg. T.C. Memo.

1993-396; Brannen v. Commissioner, 722 F.2d 695, 704 (11th Cir.

1984), affg. 78 T.C. 471 (1982); sec. 1.183-2(b), Income Tax

Regs.     The individual facts and circumstances of each case are

the primary test.     Keanini v. Commissioner, 94 T.C. 41, 46
(1990); Allen v. Commissioner, supra at 34; sec. 1.183-2(b),

Income Tax Regs.
                                -15-

     C.     Applying Factors to Facts

     Nearly all of the factors in this case indicate that

petitioners did not engage in their lemon farming activity for

profit.

     Petitioners did not conduct their activity in a businesslike

manner.    Engdahl v. Commissioner, 72 T.C. 659, 666-667 (1979);

sec. 1.183-2(b)(1), Income Tax Regs.    For example, they did not

have a written business plan, any financial statements, or any

financial data pertaining to their lemon farming activity other

than a stack of receipts.   This dearth of financial records is in

stark contrast to their financial records for their abusive

trusts.    Petitioners had copious records for the trusts including

transaction reports by category, balance sheets, and capital gain

reports.   Moreover, petitioners were unable to articulate how

they intended to earn a profit, and it is unclear from the record

how many trees they had on the property at any given time.

Petitioners also claim that they attempted changes to their lemon

farming activity when they experienced a water shortage.     While

they introduced evidence that they drilled additional wells,

petitioners did not indicate any other methods they attempted to

supply water to their land.

     Petitioners also have not shown that they studied the

accepted business, economic, and scientific practices involved in

lemon farming.   See sec. 1.183-2(b)(2), Income Tax Regs.    While

Mr. Bangs likely had some general farming experience from his

youth and he consulted an adviser regarding which crop to raise,
                               -16-

petitioners failed to introduce any evidence that they consulted

any other sources before beginning the lemon farming activity.

After they began the lemon farming activity, petitioners

consulted an expert, a supervising plant pathologist, only once.

     Petitioners also intentionally took measures that they knew

would harm their trees, such as harvesting lemons too early.      Mr.

Bangs was impatient and wanted to test how the market worked,

although he knew it could harm the trees.    There is also no

evidence that petitioners took any action to correct the poor

soil quality or did anything to overcome the water retention

problem noted by the supervising plant pathologist in 1997.

     We also found petitioners’ testimony regarding the time and

effort they spent on the lemon farming activity not credible.

See sec. 1.183-2(b)(3), Income Tax Regs.    Mr. Bangs testified

that he spent 60 to 80 hours per week, and petitioners together

spent 80 to 90 hours per week on the lemon farming activity.

Petitioners were engaged in many pursuits during the years at

issue, not the least of which was a profitable rental real estate

and investment activity.   It is difficult to imagine how anyone

would spend 80 to 90 hours per week caring for an undetermined

number of lemon trees, some of which had died, and give only

secondary attention to the rental real estate and investment

activity that generated significant gross income of approximately

$450,000 annually.   Moreover, despite claiming that they spent so

much time and effort on their lemon farming activity during the
                                 -17-

years at issue, petitioners failed to document the activity in

their trust-related financial records.

     Petitioners do not contend that they were relying upon the

property’s value increasing for them to generate profit from the

lemon farming activity.     See Bessenyey v. Commissioner, 45 T.C.

261, 274 (1965), affd. 379 F.2d 252 (2d Cir. 1967); sec. 1.183-

2(b)(4), Income Tax Regs.    They do assert, however, that they

expected the lemon trees to appreciate as fruit production

increased.   Selling the trees to realize this appreciation is

counter to their argument that they were selling lemons for

profit.

     Petitioners succeeded in other pursuits.    None was similar

to the lemon farming activity.    See Haladay v. Commissioner, T.C.

Memo. 1990-45; Daugherty v. Commissioner, T.C. Memo. 1983-188.

Petitioners grew their fiberglass business into a successful

enterprise that they sold for several million dollars.

Petitioners also have a successful rental real estate and

investment operation.   These activities, however, are quite

dissimilar to lemon farming.    Petitioners’ success in these

dissimilar activities does not lead us to conclude that the lemon

farming activity will eventually become profitable as well.      See

Haladay v. Commissioner, supra.
     We find just as telling that petitioners were involved in

unprofitable businesses, all of which they abandoned.    These

included jet ski manufacturing and catfish farming.    Yet, unlike

the other unprofitable enterprises, petitioners have not
                               -18-

abandoned the lemon farming activity.    In fact, Mr. Bangs

indicated at trial that he would await the outcome of this case

before he decided whether to drill more wells on the property.

Such conduct is inconsistent with a predominant, principal, or

primary purpose of making a profit from the activity.

     Moreover, petitioners sustained large losses from the lemon

farming activity from the start and continuing through the years

at issue.   See Golanty v. Commissioner, 72 T.C. 411, 427 (1979),

affd. without published opinion 647 F.2d 170 (9th Cir. 1981);

sec. 1.183-2(b)(6), Income Tax Regs.    The initial losses

contained an element of startup costs and involved factors unique

to lemon growing.   Petitioners were aware that it would take 10

years before the lemon trees reached full production.    The losses

continued, consistent with this forecast, for at least 9 years

after petitioners began the lemon farming activity.

     The losses continued for all of the years at issue, well

beyond the startup phase of the activity.    See Engdahl v.

Commissioner, supra; sec. 1.183-2(b)(6), Income Tax Regs.

Petitioners contend that these continued losses were due to

unforeseen events beyond their control, such as the wildfire and

the water shortage.   See sec. 1.183-2(b)(6), Income Tax Regs.   We

find petitioners’ testimony regarding the water shortage lacks

credibility.   For example, the pathologist who examined

petitioners’ trees in 1997 noted that the problems with their

trees might be due to the soil staying wet for too long.
                                -19-

Moreover, the trees on the property across from petitioners’ land

looked healthy.

     Petitioners sold their fiberglass business in the early

1980s for several million dollars and currently have a profitable

rental real estate activity.    Petitioners consider themselves

retired.   The large losses they claim from their lemon farming

activity partially offset petitioners’ substantial income from

their non-farming activities.    Petitioners therefore had an

incentive to incur losses in the farming activity.    See Jackson

v. Commissioner, 59 T.C. 312, 317 (1972).

     Petitioners have a 6,000 square foot home on the Valley

Center property where they conduct their farming activity.      Mr.

Bangs wanted to have something to do in his backyard when he

retired.   Petitioners have fond memories of farming from their

youth and had always hoped to get back to farming.   They were

pleased that they could do so raising citrus trees in California,

a warm climate.   See id.; sec. 1.183-2(b)(9), Income Tax Regs.

We find that petitioners derived personal pleasure from their

farming activity, which is an indication that petitioners did not

engage in the activity for profit.

     Based on all of the facts and circumstances, we find that

petitioners have not shown they conducted their lemon farming

activity with the primary, predominant, or principal purpose of

realizing an economic profit independent of tax savings.   See

Wolf v. Commissioner, 4 F.3d at 713; Polakof v. Commissioner, 820
                                -20-

F.2d at 323; Indep. Elec. Supply, Inc. v. Commissioner, 781 F.2d

at 726.

III. Petitioners’ Liability for Taxes on Interest Income and
     Capital Gain

     We next consider whether petitioners are liable for taxes on

interest income and capital gains they reported on their pro

forma returns, but that respondent erroneously omitted on

respondent’s initial Form 4549A.   Petitioners argue that they had

a “deal” with respondent when they signed the Form 4549A and

executed a closing agreement.   Petitioners further argue that

respondent should be prevented from asserting that petitioners

owe any amounts beyond those shown on the Form 4549A they signed.

Respondent, on the other hand, asserts that a Form 4549A is not

final and conclusive as to all issues.   Moreover, respondent

argues that the closing agreement did not determine petitioners’

total tax liability for the years at issue.   We agree with

respondent.

     It is well settled that Forms 4549A do not bind the

Commissioner.    Urbano v. Commissioner, 122 T.C. 384 (2004);

Hudock v. Commissioner, 65 T.C. 351, 362 (1975).   Only closing

agreements entered into pursuant to section 7121 are binding on

the Commissioner as to a determination of the taxpayer’s final

tax liability.   See Urbano v. Commissioner, supra at 393.

     Petitioners executed a closing agreement on Form 906 with

respect to the abusive trust scheme.   We found as a fact at trial

that the closing agreement was binding as to the matters

addressed in the agreement.   This closing agreement, however,
                                 -21-

covers only specific matters; in this case, the treatment of the

trusts.   The closing agreement does not cover other issues or

determine petitioners’ tax liability for the years at issue.

Urbano v. Commissioner, supra.    Accordingly, the closing

agreement does not prevent respondent from determining

deficiencies or penalties for the years at issue.      In fact, the

parties agreed in the closing agreement that petitioners would

report all income, expenses, and deductions on their individual

returns for the years at issue.    The closing agreement also

provides that petitioners will be liable for additional taxes,

penalties, and interest that may arise on their individual

returns by collapsing the trusts.       Accordingly, the terms of the

closing agreement provide that petitioners shall be liable for

taxes on their income for the years at issue.

      Respondent was therefore not prevented from determining that

petitioners owe taxes on interest income and capital gains they

admitted they received during the years at issue.      We find that

petitioners are liable for these taxes.

IV.   Whether Petitioners Are Liable for the Accuracy-Related
      Penalty
      The next issue is whether petitioners are liable for the

accuracy-related penalty under section 6662(a).      Respondent

determined that petitioners were negligent and therefore liable

for the penalty.7

      7
      Respondent also asserts that petitioners substantially
understated their tax and are therefore liable. Because we find
that petitioners were negligent, we need not consider whether
                                                   (continued...)
                               -22-

     Section 6662(a) and (b)(1) imposes a penalty equal to 20

percent of the portion of an underpayment of income tax

attributable to negligence.   Negligence is defined as “any

failure to make a reasonable attempt to comply with the

provisions of * * * [the Code]”.   Sec. 6662(c).   Negligence is

the lack of due care or the failure to do what a reasonable and

prudent person would do under the circumstances.     Neely v.

Commissioner, 85 T.C. 934, 947 (1985).   Respondent has the burden

of production regarding penalties and must come forward with

sufficient evidence that it is appropriate to impose the penalty.

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

(2001).

     Petitioners’ adjustments were due in part to their abusive

trusts.   We have found taxpayers negligent who use trusts in

flagrant tax avoidance schemes.    See, e.g., Wesenberg v.

Commissioner, 69 T.C. 1005, 1015 (1978); Castro v. Commissioner,

T.C. Memo. 2001-115; Hanson v. Commissioner, T.C. Memo. 1981-675,

affd. per curiam 696 F.2d 1232 (9th Cir. 1983).    We conclude that

respondent has satisfied his burden of production and has shown

that petitioners’ underpayment of tax was due to negligence.

     The accuracy-related penalty under section 6662(a) does not

apply to any portion of an underpayment, however, if a taxpayer

shows that there was reasonable cause for, and that the taxpayer

acted in good faith with respect to, that portion.    Sec.


     7
      (...continued)
petitioners substantially understated their tax.
                                 -23-

6664(c)(1); sec. 1.6664-4(b), Income Tax Regs.     Petitioners have

the burden of proving that the accuracy-related penalty does not

apply.   See Higbee v. Commissioner, supra at 446.     The

determination of whether the taxpayers acted with reasonable

cause and in good faith depends on the pertinent facts and

circumstances, including the taxpayer’s efforts to assess his or

her proper tax liability, the knowledge and experience of the

taxpayers, and the reliance on the advice of a professional.

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

     Petitioners argue that they acted with reasonable cause

regarding the lemon farming activity.     Petitioners deducted the

same expenses on previous returns, and the Commissioner did not

disallow those deductions in an earlier audit.      Sheehy v.

Commissioner, T.C. Memo. 1996-334.      A similar deduction allowed

on audit for an earlier year may be one factor to be considered

in determining whether the accuracy-related penalty applies.          See

Stewart v. Commissioner, T.C. Memo. 2002-199; Sheehy v.

Commissioner, supra.

     We note that the inquiry into whether an activity was

engaged in for profit is a facts and circumstances test.        We find

it was reasonable for petitioners to believe the deductions were

permitted when a previous audit did not require changes.        See

Sheehy v. Commissioner, supra.    Based on all of the facts and

circumstances of this case, we find that petitioners had

reasonable cause for and acted in good faith with respect to the

treatment of their lemon farming activity.     We accordingly find
                               -24-

that petitioners are not liable for the accuracy-related penalty

as it relates to this portion of the underpayment.

     The other items on petitioners’ returns for the years at

issue are not accorded the same treatment.   These other non-lemon

farming activity items, including the abusive trust items, were

not considered in the prior audit.    Petitioners have not shown a

genuine effort to assess their proper tax liability, nor have

they shown that they relied on the advice of a professional with

respect to these items.   See sec. 1.6664-4(b)(1), Income Tax

Regs.   Petitioners have not shown they acted with reasonable

cause and in good faith with respect to these non-lemon farming

activity items, and, accordingly, they are liable for the

accuracy-related penalty on the portion of the underpayment

attributable to these items.

     To reflect the foregoing and the concessions of the parties,


                                           Decision will be entered

                                      under Rule 155.
