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and (b) for each of the years 1988 and 1989 that is attributable
to the unreported embezzlement income; and (3) that, under the
facts and circumstances presented here, it is not inequitable
under section 6013(e)(1)(D) to hold petitioner liable for the
portion of the deficiency (a) for 1987 that is attributable to
that embezzlement income and those erroneous deductions and (b)
for each of the years 1988 and 1989 that is attributable to that
embezzlement income.
Unreported Embezzlement Income
Section 6013(e)(1)(C)
In cases involving omissions of income, such as the issue
presented here involving the unreported embezzlement income, the
courts have consistently held that the knowledge contemplated by
section 6013(e)(1)(C) is knowledge of the underlying transaction,
and not of the tax consequences of that transaction. Quinn v.
Commissioner, 524 F.2d 617, 626 (7th Cir. 1975), affg. 62 T.C.
223 (1974); see Resser v. Commissioner, supra at 1535. In
evaluating whether petitioner had no reason to know that there
was a substantial understatement within the meaning of section
6013(e)(1)(C), the Court must inquire whether a reasonably
prudent person, under the circumstances of petitioner, could have
been expected to know at the time of signing each of the returns
in question that each such return contained a substantial under-
statement or that further investigation was warranted. Resser v.
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