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Court, and leave shall be given freely when justice so requires.
Rule 41(a). A party may move to amend the pleadings to conform
to the proof presented at trial. Rule 41(b)(2). Prejudice to
the other party is the key factor in deciding whether to allow an
amendment to the pleadings. Kroh v. Commissioner, 98 T.C. 383,
389 (1992).
To support their claim for a theft loss deduction,
petitioners provided evidence showing that they had not reported
certain income. We believe they are not prejudiced by
respondent’s request that the Court also consider that evidence
to find increased deficiencies. See Sharvy v. Commissioner, 67
T.C. 630, 641-642 (1977), affd. 566 F.2d 1118 (9th Cir. 1977).
Respondent may amend the pleadings to conform to the proof. Rule
41(b)(2).
4. Whether Petitioners Are Liable for Increased
Deficiencies Due to Their Failure To Report Legal Fees
and Rental Income
Petitioners contend that they are not taxable on unreported
legal fees and rental income of $67,437 for 1995 and $87,942.76
for 1998 because Edgar embezzled at least that much from them
without petitioners’ knowledge.
We disagree that petitioners are not taxable on these
amounts. Edgar diverted legal fees and rental checks by
depositing them into petitioner’s Big Bear account. Petitioner
had access to those funds, which were commingled with other funds
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