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A substantial understatement of income tax is defined as an
understatement constituting the greater of 10 percent of the tax
required to be shown on a Federal income tax return or $5,000.
Sec. 6662(d)(1)(A). An understatement is reduced by that portion
of the understatement which is attributable to either substantial
authority for the claimed tax treatment of the item or adequate
disclosure of and reasonable basis for the claimed tax treatment
of the item. Sec. 6662(d)(2)(B).
Under section 7491(c), respondent has the burden of
production with respect to any penalty. Once respondent meets
the burden of production, the taxpayer, however, continues to
have the burden of proof with respect to whether respondent’s
determination of the penalty is correct. Rule 142(a); Higbee v.
Commissioner, 116 T.C. 438 (2001).
Petitioner argues that, with respect to his 2000 Federal
income tax return and his treatment of Johnston Island wages
reported thereon as nontaxable income, his reliance on section
1.931-1, Income Tax Regs., was reasonable and the pending
litigation was in good faith. Petitioner argues that the
regulation and the pending litigation, combined with the
disclosure petitioner made on his 2000 individual Federal income
tax return, establish a reasonable basis for his tax treatment of
his Raytheon wages as nontaxable income.
Respondent seems to argue that the existence of section 931
(in which Johnston Island is not listed as a specified possession
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Last modified: May 25, 2011