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We sustain respondent’s disallowance of the $6,178 in
additional legal fees relating to the arbitration award and the
$8,520 in additional itemized deductions.
Respondent has asserted against petitioners a substantial
understatement penalty with respect to the failure of petitioners
to report as income on their original 2001 joint Federal income
tax return the $148,744 that was paid on the arbitration award in
2001.
Under section 6662, a substantial understatement of tax
exists if the amount of the understatement of income tax exceeds
the greater of: (1) 10 percent of the tax required to be shown
on the return; or (2) $5,000. Sec. 6662(d)(1)(A).
Respondent has satisfied his burden of production under
section 7491(c) because respondent has shown that petitioners, on
their 2001 joint Federal income tax return, understated their tax
by more than 10 percent and by more than $5,000 by failing to
report the $148,744 arbitration award as income.
Under sections 6662(d)(2)(B)(i) and 6664(c)(1), the amount
of a tax understatement may be reduced by the portion thereof
that is attributable to substantial authority or to reasonable
cause and good faith.
Although petitioners now concede that the entire $148,744 is
includable in income, we find that petitioners had reasonable
cause for the treatment of the portion thereof (namely, $59,498)
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