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underlying tax claim. Without a final judgment on the merits,
res judicata cannot apply.
Next we consider whether collateral estoppel precludes
respondent from determining a deficiency larger than the one
claimed in the bankruptcy proceeding. Under the doctrine of
collateral estoppel, or issue preclusion, the judgment in the
prior suit precludes, in the second cause of action, litigation
of issues actually litigated and necessary to the outcome of the
first action. Parklane Hosiery Co. v. Shore, 439 U.S. 322, 326
(1979). In Montana v. United States, 440 U.S. 147 (1979), the
Supreme Court used a three-prong test to determine when the use
of collateral estoppel is appropriate. The Supreme Court looked
at whether the issues in the subsequent litigation were, in
substance, the same as those in the first case; whether the
controlling facts or legal principles have significantly changed
since the first litigation; and whether other special
circumstances warrant an exception to the normal rules of
preclusion. Id. at 155. In Peck v. Commissioner, 90 T.C. 162,
166 (1988), affd. 904 F.2d 525 (9th Cir. 1990), we held that
collateral estoppel applies in the context of a factual dispute
only when the following conditions are satisfied: (1) The issue
in the second suit must be identical in all respects with the one
decided in the first suit; (2) there must be a final judgment
rendered by a court of competent jurisdiction; (3) collateral
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