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All section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure. The issues for
decision are: (1) Whether William E. Flanagin's (Mr. Flanagin)
software development activity was an activity engaged in for
profit; and (2) whether petitioners are liable for penalties
pursuant to section 6662 for 1992 and 1993 due to a substantial
understatement of income tax.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulations of facts and the attached exhibits are
incorporated herein by this reference. At the time they filed
their petition, petitioners, husband and wife, resided in
Illinois.
I. The Software Development Activity
Prior to and during the years in issue, Mr. Flanagin was a
mainframe computer consultant. During this time, Mr. Flanagin
also conducted an activity (the software development activity)
that involved writing new software and trouble-shooting old
software for use on the Zenith Z-100 computer (Z-100).
Zenith Data Systems (Zenith) first produced the Z-100 in
late 1982. By this time, IBM had introduced the IBM personal
computer (PC) and had taken the industry by storm. The Z-100 was
non-PC compatible, and in 1986, Zenith stopped production of the
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