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circumstances that gave rise to the error on the tax return, not
merely of the tax consequences flowing from those circumstances.”
C. Did Petitioner Have Reason To Know of the Substantial
Understatement?
After applying the standard followed by the Court of Appeals
for the Second Circuit and considering the relevant factors, we
hold that petitioner had reason to know of the substantial
understatements. Petitioner was, to some extent, unsophisticated
in business, lacked a formal business education, and had a
relatively insignificant role in the business and financial
affairs of Mary Catherine and the related entities. Petitioner’s
lack of business acumen, however, was not an impediment to her
knowledge and understanding of the facts pertaining to the
transaction which underlies the substantial understatement.
The deductions petitioner and Mr. Pierce claimed were based
on a reduction in value of real estate holdings. Those
reductions were reflected in financial statements for business
purposes, but no taxable event (i.e., sale or exchange) had
occurred as of the time the deductions were claimed on the
Federal tax returns. Petitioner did not need business acumen to
understand all of the facts pertaining to the transaction. The
loss deductions the Pierces claimed were relatively simple in
form and effect and were not the result of some complex series of
transactions. The Pierces were aware of the claimed real estate
losses, and they may have been under the mistaken impression that
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