Stephen R. Kelley & Isabelle Kelley

United States Tax Court

T.C. Memo. 2023-126

STEPHEN R. KELLEY AND ISABELLE KELLEY,

Petitioners

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent

__________

Docket No. 15069-19. Filed October 23, 2023.

__________

Stephen R. Kelley and Isabelle Kelley, pro sese.

Robert P. Brown, Peter N. Tran, and Gordon P. Sanz, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

COPELAND, Judge: Petitioners, Stephen and Isabelle Kelley,

reported zero gross income and zero taxable income on their 2017 joint

federal income tax return. On the basis of third-party information

returns indicating that the Kelleys received taxable income in 2017, the

Commissioner of Internal Revenue (Commissioner) determined a

deficiency and, in his Answer, asserted an accuracy-related penalty

under section 6662(a) and (b)(1) 1 for negligence or disregard of rules or

regulations. At trial and on brief, the Kelleys contested the procedural

validity of the notice of deficiency, the legal accuracy of the information

returns, the Commissioner’s grounds for the penalty, and whether the

penalty was properly authorized.

1 Unless otherwise indicated, statutory references are to the Internal Revenue

Code, Title 26 U.S.C. (I.R.C. or Code), in effect at all relevant times, regulation

references are to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all

relevant times, and Rule references are to the Tax Court Rules of Practice and

Procedure. Some dollar amounts are rounded.

Served 10/23/23

2

[*2] FINDINGS OF FACT

The Kelleys were residents of Texas when they timely filed their

Petition.

Mr. and Mrs. Kelley each hold master’s degrees in geology and

worked as geologists in 2017. Mr. Kelley worked for Sanchez Oil and

Gas Corp. (Sanchez Oil & Gas), Mrs. Kelley for Core Laboratories LP

(Core Labs). Mr. Kelley received $176,273 in compensation from

Sanchez Oil & Gas in 2017, from which $42,135 was withheld for federal

income tax. Sanchez Oil & Gas reported this information to Mr. Kelley

and the Internal Revenue Service (IRS) using Form W–2, Wage and Tax

Statement. Mrs. Kelley received $149,763 in compensation from Core

Labs in 2017, from which $33,610 was withheld for federal income tax.

Core Labs reported this information to Mrs. Kelley and the IRS using

Form W–2. Mrs. Kelley also received $817 in qualified dividends from

Core Labs in 2017. These dividends were received on Mrs. Kelley’s

behalf by Solium Capital LLC (Solium), which reported them to Mrs.

Kelley and the IRS using Form 1099–DIV, Dividends and Distributions.

On their timely filed joint 2017 Form 1040EZ, Income Tax Return

for Single and Joint Filers With No Dependents, the Kelleys reported

zero gross income, zero taxable income, and $96,290 in withholdings. 2

The Kelleys accordingly claimed a refund of $96,290. They attached to

their return two Forms 4852, Substitute for Form W–2, Wage and Tax

Statement, or Form 1099–R, Distributions From Pensions, Annuities,

Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc.,

reporting zero in “wages, tips, and other compensation” from Sanchez

Oil & Gas and Core Labs, respectively, but replicating the withholding

amounts for federal income tax and payroll taxes that Sanchez Oil &

Gas and Core Labs reported on the Forms W–2. On line 9 of their

respective Forms 4852 (asking how the taxpayer determined the

corrected amounts), Mr. and Mrs. Kelley wrote: “I did not receive any

‘wages’ as defined in IRC Section 3401(a) and 3121(a).” The Kelleys also

attached to their return a document titled “Statement to Correct

Incorrectly Reported 1099–DIV Information Return,” in which they

claimed that “[n]o dividends were received by [Mrs. Kelley] from

[Solium] which were connected with any ‘trade or business’ or otherwise

2 Line 7 of the 2017 Form 1040EZ reads: “Federal income tax withheld from

Form(s) W–2 and 1099.” The Kelleys crossed out “Federal income tax” and inserted

“All monies.” $96,290 is the sum of the federal income tax and payroll taxes (i.e., Social

Security tax and Medicare tax) withheld by Sanchez Oil & Gas and Core Labs from the

Kelleys’ 2017 compensation.

3

[*3] constituted gains, profits, or income within the meaning of relevant

law.”

On July 9, 2018, the IRS sent the Kelleys their claimed refund of

$96,290 plus interest. On May 28, 2019, the IRS issued to the Kelleys a

notice of deficiency, determining a $76,565 income tax deficiency 3 and a

$19,565 accuracy-related penalty for an underpayment due to a

substantial understatement of income tax (substantial understatement

penalty). See I.R.C. § 6662(a), (b)(2). The notice of deficiency based

these determinations on the Forms W–2 from Sanchez Oil & Gas and

Core Labs and the Form 1099–DIV from Solium. The first page of the

notice of deficiency lists an “AUR control number,” referring to the IRS’s

automated underreporter program (AUR), as further explained infra

p. 6.

In the Commissioner’s Answer to the Petition, he conceded that

the Kelleys are not liable for the substantial understatement penalty.

He represented that the IRS official who made the initial determination

to assess that penalty did not obtain the written supervisory approval

required by section 6751(b)(1). However, the Answer newly asserted an

accuracy-related penalty under section 6662(a) and (b)(1) for an

underpayment due to negligence or disregard of rules or regulations

(negligence/disregard penalty). The Answer was signed by both Yvette

Nunez, the IRS attorney initially assigned to the Kelleys’ case, and Paul

Feinberg, Ms. Nunez’s immediate supervisor at the time.

OPINION

I. Burden of Proof

Generally, the Commissioner’s determinations in a notice of

deficiency are presumed correct, and the taxpayer bears the burden of

proving that those determinations are erroneous. See Rule 142(a);

3 This deficiency amount appropriately does not include the payroll taxes

refunded to the Kelleys. See I.R.C. § 6211 (defining “deficiency” to encompass only

income, gift, estate, and certain excise taxes). Moreover, since this is a deficiency

proceeding, we do not have jurisdiction over those payroll taxes. See I.R.C. § 6214(a)

(granting the Tax Court “jurisdiction to redetermine the correct amount of the

deficiency” (emphasis added)); see also Ietto v. Commissioner, T.C. Memo. 1996-332, 72

T.C.M. (CCH) 166, 166 (“The United States Tax Court is a court of limited jurisdiction.

Generally, this jurisdiction is limited to income, estate, gift, and certain excise taxes

which are subject to the deficiency notice requirements of sections 6212(a) and 6213(a).

This Court has no jurisdiction over FICA [i.e., payroll] taxes imposed on an employee.”

(Citations omitted.)).

4

[*4] Welch v. Helvering, 290 U.S. 111, 115 (1933). In cases of unreported

income, the Commissioner must establish an evidentiary foundation

connecting the taxpayer with the income-producing activity or otherwise

demonstrate that the taxpayer actually received income. See Portillo v.

Commissioner, 932 F.2d 1128, 1133–34 (5th Cir. 1991), aff’g in part,

rev’g in part T.C. Memo. 1990-68; Walquist v. Commissioner, 152 T.C.

61, 67 (2019). Once the Commissioner makes the required threshold

showing, the burden typically shifts to the taxpayer to prove by a

preponderance of the evidence that the Commissioner’s determinations

are arbitrary or erroneous. See Portillo v. Commissioner, 932 F.2d at

1133–34; Walquist, 152 T.C. at 67–68. The Commissioner’s threshold

showing generally must include “reasonable and probative information”

beyond a mere third-party information return, such as a Form W–2 or

Form 1099–DIV. See I.R.C. § 6201(d); see also Portillo v. Commissioner,

632 F.2d at 1134.

Even if the Commissioner makes the required threshold showing

with respect to an alleged item of unreported income, he will retain the

burden of proof with respect to that item if the taxpayer (1) introduces

credible evidence that he did not receive the income and (2) has

maintained all statutorily required records and cooperated with the

Commissioner. I.R.C. § 7491(a). Additionally, the Commissioner always

bears the initial burden of production with respect to any asserted

penalty against an individual. I.R.C. § 7491(c). Accordingly, the

Commissioner must come forward with sufficient evidence that it is at

least prima facie appropriate to impose the penalty. Higbee v.

Commissioner, 116 T.C. 438, 446 (2001). Moreover, in a case like this

one, where the Commissioner asserts a penalty in an answer (rather

than the notice of deficiency), the Commissioner bears the full burden of

proof regarding the penalty, including the taxpayer’s lack of reasonable

cause or any other applicable affirmative defense. See Rule 142(a)(1);

Estate of Hoensheid v. Commissioner, T.C. Memo. 2023-34, at *47; Full-

Circle Staffing, LLC v. Commissioner, T.C. Memo. 2018-66, at *42–43,

aff’d in part, appeal dismissed in part, 832 F. App’x 854 (5th Cir. 2020).

II. Procedural Validity of the Notice of Deficiency

The Kelleys raise the jurisdictional issue of whether the notice of

deficiency was validly issued, since it does not bear the name of any IRS

officer or employee. As we have repeatedly held, “[a] valid petition is

the basis of the Tax Court’s jurisdiction. To be valid, a petition must be

filed from a valid statutory notice.” Stamm Int’l Corp. v. Commissioner,

84 T.C. 248, 252 (1985) (first citing Midland Mortg. Co. v. Commissioner,

5

[*5] 73 T.C. 902, 907 (1980); and then citing McCue v. Commissioner,

1 T.C. 986, 988 (1943)).

Section 6212(a) authorizes the “Secretary” to send a notice of

deficiency if she “determines that there is a deficiency in respect of any

tax.” (Emphasis added.) (Section 7701(a)(11)(B) provides that the term

“Secretary,” as used in the Code, means “the Secretary of the Treasury

or [her] delegate.”) The U.S. Court of Appeals for the Fifth Circuit 4 has

indicated that such a determination means “a thoughtful and considered

determination that the United States is entitled to an amount not yet

paid.” Portillo v. Commissioner, 932 F.2d at 1132 (quoting Scar v.

Commissioner, 814 F.2d 1363, 1369 (9th Cir. 1987), rev’g 81 T.C. 855

(1983)). The Fifth Circuit further indicated that “the word

‘determination’ irresistibly connotes consideration, resolution,

conclusion, and judgment.” Id. (quoting Terminal Wine Co. v.

Commissioner, 1 B.T.A. 697, 701 (1925)).

Section 7701(a)(12)(A) clarifies that the Secretary of the

Treasury’s (Secretary) powers may be delegated both directly and

“indirectly by one or more redelegations of authority.” The Secretary

has delegated the authority to determine deficiencies and to issue

notices of deficiency to the Commissioner and to IRS district directors,

directors of service centers, and regional directors of appeals. See Treas.

Reg. § 301.6212-1(a); Treas. Order 150-10 (Apr. 22, 1982). Moreover,

Treasury Regulation § 301.7701-9(c) authorizes the Commissioner to

redelegate these powers to other officers or employees under his

supervision and control and to authorize further delegation of these

powers by his delegates. The Commissioner has redelegated the

authority to issue notices of deficiency to various managers, directors,

and other officials of the IRS, identified by job title. See I.R.S. Deleg.

Order 4-8 (Rev. 1), Internal Revenue Manual (IRM) 1.2.43.9 (Sept. 4,

2012).

The notice of deficiency sent to the Kelleys does not list the name

of any IRS officer or employee but does bear an “AUR control number.”

4 This Court follows a court of appeals decision that is squarely in point if

appeal from our decision lies to that court of appeals alone. Golsen v. Commissioner,

54 T.C. 742, 757 (1970), aff’d, 445 F.2d 985 (10th Cir. 1971). Appeal of the present case

would lie exclusively to the Fifth Circuit, absent a stipulation by the parties to the

contrary. See I.R.C. § 7482(b)(1)(A).

6

[*6] See IRM 4.19.2 (Aug. 7, 2018) (“IMF Automated Underreporter

(AUR) Control”). 5 The IRM explains:

Potential AUR cases are systemically identified through

computer matching of tax returns with corresponding

Information Returns Master File (IRMF) payer

information documents. Cases are selected for inventory

in a manner determined to provide overall compliance

coverage. Selected cases undergo an in-depth review by a

tax examiner to identify underreported and/or over-

deducted issues which require further explanation to

resolve the discrepancy.

IRM 4.19.3.1.1 (Aug. 22, 2017).

The Kelleys point out that the AUR is not listed as a delegate in

Delegation Order 4-8. They further contend that computer algorithms

are not capable of “thoughtful and considered determination,” nor of

“consideration, resolution, conclusion, and judgment.” Portillo v.

Commissioner, 932 F.2d at 1132. However, the IRM specifies:

Tax examiners perform an in-depth analysis of each case

[flagged by the AUR] and determine if the discrepant

income or deduction(s) in question are satisfactorily

identified or addressed on the tax return. If so, they close

the case. If reasonable doubt remains, they send the

[taxpayer] either:

• An AUR Notice, CP 2000 or

• An Initial Contact Letter, CP 2501

IRM 4.19.3.2(11) (Dec. 15, 2017). By reason of the presumption of

regularity, we presume that the IRS followed these provisions of the

IRM when issuing to the Kelleys first a CP 2501, then a CP 2000, and

finally a notice of deficiency. 6 “The presumption of regularity supports

5 Citations of provisions of the IRM relating to the AUR are of those provisions

in effect when the notice of deficiency was issued (viz, May 28, 2019).

6 No CP 2501 is in the record. However, the record includes the first page of a

CP 2000 addressed to the Kelleys and dated March 11, 2019. The CP 2000 states in

part: “Thank you for your response to our previous notice. Based on your response,

we’ve determined you owe $122,392 . . . .” It is evident that the Kelleys had received a

prior notice and responded and that the Commissioner, through his authorized

delegates, considered their response before issuing the notice of deficiency.

7

[*7] the official acts of public officers and, in the absence of clear

evidence to the contrary, courts presume that they have properly

discharged their official duties.” United States v. Chem. Found., Inc.,

272 U.S. 1, 14–15 (1926). A corollary principle is that “all necessary

prerequisites to the validity of official action are presumed to have been

complied with, and that where the contrary is asserted it must be

affirmatively shown.” Lewis v. United States, 279 U.S. 63, 73 (1929); see

also Harriss v. Commissioner, T.C. Memo. 2021-31, at *10. Given these

presumptions, we find by a preponderance of the evidence that the

notice of deficiency sent to the Kelleys reflected a “thoughtful and

considered determination,” made by a duly authorized delegate of the

Secretary, that the Kelleys understated the amount of tax due on their

2017 return.

We thus hold that the notice of deficiency is valid and that we

have jurisdiction over this case.

III. 2017 Gross Income

The Kelleys do not dispute receiving the amounts reported on the

Forms W–2 from Sanchez Oil & Gas and Core Labs and the Form 1099–

DIV from Solium. The Kelleys do not dispute that the payments from

Sanchez Oil & Gas and Core Labs were made in exchange for the

Kelleys’ labor, nor that the payments reported by Solium were corporate

dividends. They make no contention that any of these amounts

constituted a gift, a loan repayment, or any other transaction that falls

within an exclusion from gross income.

Gross income is generally defined by section 61 as “income from

whatever source derived.” The Supreme Court long ago established that

gross income includes all “accessions to wealth, clearly realized, and

over which the taxpayers have complete dominion,” absent an explicit

exclusion. Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 431

(1955). The Court in Glenshaw Glass clarified that gross income is not

limited to “the gain derived from capital, from labor, or from both

combined.” Id. at 430–31 (quoting Eisner v. Macomber, 252 U.S. 189,

207 (1920)). Here, the evidence clearly shows that all the amounts

reported on the Forms W–2 and Form 1099–DIV were unexcluded,

realized accessions to the Kelleys’ wealth—and, in fact, that these

amounts were gains derived from their capital and/or labor. Therefore,

we find by a preponderance of the evidence that all these amounts were

gross income that the Kelleys should have reported on their 2017 tax

return. It is irrelevant whether the burdens of production or proof

8

[*8] shifted to the Commissioner under section 6201(d) or 7491(a). See

Knudsen v. Commissioner, 131 T.C. 185, 189 (2008) (“In a case where

the standard of proof is preponderance of the evidence and the

preponderance of the evidence favors one party, we may decide the case

on the weight of the evidence and not on an allocation of the burden of

proof.”), supplementing T.C. Memo. 2007-340.

IV. Section 6662(a) Penalty

A. Section 6751(b)(1) Supervisory Approval

1. Timing of Approval

Section 6751(b)(1) provides that “[n]o penalty under this title [i.e.,

the Code] shall be assessed unless the initial determination of such

assessment is personally approved (in writing) by the immediate

supervisor of the individual making such determination.” This Court

has held that section 6751(b)(1) requires supervisory approval to be

procured before the first formal communication to the taxpayer of the

decision to assert the penalty at issue. See, e.g., Clay v. Commissioner,

152 T.C. 223, 249 (2019), aff’d, 990 F.3d 1296 (11th Cir. 2021).

Here, in the notice of deficiency, the Commissioner determined a

substantial understatement penalty. The Commissioner conceded that

penalty in his Answer, stating that the IRS official who initially

determined the penalty did not obtain written supervisory approval.

The Answer newly asserted a negligence/disregard penalty. Moreover,

the Answer was signed by both Ms. Nunez, the IRS attorney who drafted

the Answer, and Mr. Feinberg, her immediate supervisor. Thus, before

the first formal communication to the Kelleys regarding the

negligence/disregard penalty, that penalty had been approved by the

immediate supervisor of the official who proposed it. 7

7 The IRS sent the Kelleys a Notice CP 2000, or “30-day letter,” on March 11,

2019, before issuing the notice of deficiency. The record includes only the first page of

the CP 2000, but that page contains the entire “Summary of proposed changes.”

Within that summary, only one penalty is listed: “Substantial tax understatement

penalty.” Because that phrase reasonably corresponds only to the substantial

understatement penalty, we are satisfied that the Commissioner did not formally

communicate his decision to assert the negligence/disregard penalty until he filed the

Answer. Below we discuss whether the Commissioner’s earlier communication

regarding the substantial understatement penalty precluded the later communication

regarding the negligence/disregard penalty from satisfying the section 6751(b)(1)

requirement.

9

[*9] 2. Individuation of Penalties Under Section 6662

The Kelleys do not agree that the negligence/disregard penalty

asserted in the Answer was asserted for the first time in the Answer, in

light of the wording and structure of section 6662. Section 6662(a)

imposes a penalty equal to 20% of any portion of an underpayment of

tax attributable to “1 or more of” the eight causes listed in section

6662(b). Accordingly, even if more than one of the causes applies to a

given portion of an underpayment, the taxpayer must pay an additional

20% of that portion only once. See Treas. Reg. § 1.6662-2(c). 8 On the

face of the statute, then, section 6662(a) imposes a single penalty, albeit

one whose rationale may differ between taxpayers, or between different

portions of a particular taxpayer’s overall underpayment. If this

interpretation of the statute is correct, then the Commissioner’s

assertion of a penalty in the Answer (under section 6662(a) by reason of

subsection (b)(1)) was not the “initial determination” of that penalty,

since it had already been determined (albeit by reason of subsection

(b)(2)) in the notice of deficiency. Accordingly, Mr. Feinberg’s approval

of Ms. Nunez’s draft of the Answer would not suffice for purposes of

section 6751(b)(1).

However, we cannot accept the Kelleys’ interpretation of what

constitutes “the penalty” under section 6662 (at least for purposes of

section 6751(b)(1)). The Kelleys’ interpretation would give carte blanche

to IRS officials to assert additional causes under section 6662(b) after a

supervisor approved a penalty under one or more other causes. For

instance, an IRS revenue agent might get approval to penalize a

taxpayer by reason of section 6662(b)(1) (negligence or disregard of rules

or regulations) but, upon receiving convincing rebuttal from the

taxpayer, assert a penalty by reason of section 6662(b)(3) (substantial

valuation misstatement)—perhaps even enhanced to a 40% penalty for

gross valuation misstatements under section 6662(h). If the Kelleys are

correct, then the revenue agent would not need further supervisory

approval for the second penalty assertion, because the second penalty

would be the “same” as the first (approved) penalty.

8 The penalty is increased to 40% of the relevant portion of the underpayment

if at least one of the causes is a “gross valuation misstatement” (as defined in section

6662(h)) or a “nondisclosed noneconomic substance transaction” (as defined in section

6662(i)), neither of which is at issue in this case. However, the same “nonstacking”

principle governs: The 40% penalty is imposed only once, regardless of how many of

the eight causes under section 6662(b) apply.

10

[*10] This result would fly in the face of Congress’s stated purpose in

enacting section 6751(b)(1): to ensure that penalties “only be imposed

where appropriate and not as a bargaining chip.” Williams v.

Commissioner, 151 T.C. 1, 8 (2018) (quoting S. Rep. No. 105-174, at 65

(1998), as reprinted in 1998-3 C.B. 537, 601). The revenue agent in our

example would have free rein to use the second penalty assertion (and

further assertions as needed), even if unjustified, to encourage the

taxpayer to settle. This posturing is precisely what Congress evidently

sought to prevent. See Chai v. Commissioner, 851 F.3d 190, 219 (2d Cir.

2017), aff’g in part, rev’g in part T.C. Memo. 2015-42. Indeed, we have

repeatedly held that if the first formal communication of penalties to a

taxpayer indicates a section 6662(a) penalty by reason of some of the

section 6662(b) causes but not others, then the Commissioner is barred

from later asserting a penalty by reason of any of the initially excluded

causes without further supervisory approval. (He would not be so

barred if all the section 6662(b) causes amounted to the “same” penalty.)

See, e.g., Conrad v. Commissioner, T.C. Memo. 2023-100, at *82–83;

Estate of Ronning v. Commissioner, T.C. Memo. 2019-38, at *12–13,

*45–46, aff’d, 830 F. App’x 279 (11th Cir. 2020); see also Palmolive Bldg.

Invs., LLC v. Commissioner, 152 T.C. 75, 87 (2019) (“Although the title

of section 6662 refers to a (singular) ‘penalty’, section 6662 imposes

various distinct penalties, each subpart of which must be separately

approved for purposes of section 6751(b)(1).”); McCarthy v.

Commissioner, T.C. Memo. 2020-74, at *26–29 (finding the supervisory

approval requirement unmet for the penalty under section 6662(a) and

(b)(2) when the alleged approval stated simply “6662 penalty approved”

without identifying any causes under section 6662(b)).

We therefore hold that each of the eight causes of an

underpayment listed in section 6662(b) yields a distinct penalty for

purposes of the supervisory approval requirement under section

6751(b)(1). Accordingly, the Commissioner was on firm procedural

ground in asserting the negligence/disregard penalty against the

Kelleys after determining the substantial understatement penalty

without supervisory approval.

3. Authority to Assert Penalty

Section 6214(a) impliedly authorizes the Secretary and her

delegates to assert penalties in pleadings before this Court. 9 The

9 Section 6214(a) provides, in relevant part, that “the Tax Court shall have

jurisdiction to . . . determine whether any additional amount, or any addition to the

11

[*11] Commissioner is a delegate of the Secretary for this purpose, and

the IRS Chief Counsel is likewise a delegate of the Commissioner. See

I.R.C. § 7803(b)(2)(D) (authorizing the Chief Counsel “to represent the

Commissioner in cases before the Tax Court”). Therefore, Ms. Nunez

had authority, as a Chief Counsel attorney, to make the “initial

determination” of the negligence/disregard penalty against the Kelleys

in the Answer, such that Mr. Feinberg’s signature on the Answer

satisfied the requirement of section 6751(b)(1).

The Kelleys contend that attorneys in the IRS Office of Chief

Counsel lack authority to assert penalties. They refer us to Graev v.

Commissioner, 149 T.C. 485, 527–34 (2017) (Buch, J., concurring in part

and dissenting in part), supplementing and overruling in part 147 T.C.

460 (2016), where Judge Buch argued that Chief Counsel attorneys lack

delegated authority to issue notices of deficiency and therefore may not

make the “initial determination” of a penalty asserted in such a notice.

That argument has no applicability here; this case does not involve Chief

Counsel attorneys issuing a notice of deficiency. Rather, here, the Chief

Counsel attorney asserted penalties for the first time in the Answer filed

in this Court. We have held that the Chief Counsel or his delegates (i.e.,

attorneys in the IRS Office of Chief Counsel) are authorized, by virtue

of their role as the Commissioner’s representatives in this Court, see

I.R.C. §§ 7803(b), 7452, to assert penalties in an answer. “It is well

established that the Commissioner may assert penalties in his answer.”

Koh v. Commissioner, T.C. Memo. 2020-77, at *5 (first citing I.R.C. §

6214(a); then citing Chai v. Commissioner, 851 F.3d at 221; and then

citing Graev, 149 T.C. 485). “It follows that his representative in this

Court also has this authority.” Id. (first citing Roth v. Commissioner,

T.C. Memo. 2017-248, at *11, aff’d, 922 F.3d 1126 (10th Cir. 2019); then

citing Rule 142(a); then citing Graev, 149 T.C. at 491–92, 498; and then

citing Estate of Jung v. Commissioner, 101 T.C. 412, 448 (1993)). Thus,

we reject the Kelleys’ argument.

B. “Underpayment”

Section 6662(a) imposes a penalty equal to 20% of any

underpayment of tax attributable to one or more of the eight causes

listed in section 6662(b). Section 6664(a) defines “underpayment” of a

tax should be assessed, if claim therefor is asserted by the Secretary at or before the

hearing or a rehearing.” (Emphasis added.)

12

[*12] particular tax to mean the amount by which the correct amount of

the tax exceeds the excess of

(1) the sum of—

(A) the amount shown as tax by the taxpayer

on his return, plus

(B) amounts not so shown [but] previously

assessed (or collected without assessment),[10] over

(2) the amount of rebates [already] made [with

respect to the tax period at issue].

“Rebates” include abatements, credits, and refunds. Treas. Reg.

§ 1.6664-2(e).

Here, given our determination of unreported gross income, the

Kelleys had an underpayment for their 2017 tax year within the

meaning of section 6664(a): Their correct tax liability was well above the

zero tax liability reported on their return (and the record indicates no

amounts previously assessed or collected without assessment). For

clarity, we emphasize that the Kelleys had an underpayment at the time

they submitted their return; when they requested and received a refund

of the withholdings made by Sanchez Oil & Gas and Core Labs, their

underpayment increased.

C. Negligence and Disregard

Section 6662(a) and (b)(1) imposes a penalty for an underpayment

of tax attributable to “[n]egligence or disregard of rules or regulations.”

Section 6662(c) provides that for this purpose, “the term ‘negligence’

includes any failure to make a reasonable attempt to comply with the

provisions of this title [i.e., the Code], and the term ‘disregard’ includes

any careless, reckless, or intentional disregard.”

The Kelleys’ failure to report the amounts shown as gross income

on the Forms W–2 and Form 1099–DIV was a clear disregard of the clear

rule that gross income includes “all income from whatever source

derived.” I.R.C. § 61(a); see also Treas. Reg. § 1.61-1(a) (“Gross income

10 Amounts are considered “previously assessed” only if the IRS assessed those

amounts before the taxpayer filed a return, such as occurs with jeopardy assessments

under section 6861. See Treas. Reg. § 1.6664-2(d). The amount considered “collected

without assessment” is only the unrefunded and uncredited portion of the excess (if

any) of tax payments made before the filing of the return (including wage withholding

and estimated tax payments) over the tax shown on the return. Id. On the basis of

the record, neither of these definitions applies to the Kelleys’ 2017 income tax.

13

[*13] means all income from whatever source derived, unless excluded

by law.”). The general definition of taxable “gross income” in section 61

explicitly includes “[c]ompensation for services . . . [and] [d]ividends.”

I.R.C. § 61(a)(1), (7). The Code could not have more clarity. For the

Kelleys, gross income included the compensation from Sanchez Oil &

Gas and Core Labs and the dividends reported by Solium, and the

Kelleys were at least careless in disregarding the rules requiring them

to report these amounts.

D. Adequate Disclosure and Reasonable Basis

The Kelleys believe that they qualify for the exception to the

section 6662(a) penalty by virtue of their making an adequate disclosure

in their return. Treasury Regulation § 1.6662-3(c) excuses a taxpayer’s

disregard of rules or regulations if the underpayment is attributable to

a position that the taxpayer adequately disclosed on the return. Treas.

Reg. §§ 1.6662-3(c), 1.6662-7. However, the disclosure must be made

using Form 8275, Disclosure Statement, or Form 8275–R, Regulation

Disclosure Statement, see Treas. Reg. § 1.6662-3(c)(1), neither of which

the Kelleys filed with their return. In any event, the adequate disclosure

exception does not apply if the taxpayer’s position lacks a “reasonable

basis.” Id. Reasonable basis is defined as “a relatively high standard of

tax reporting, that is, significantly higher than not frivolous or not

patently improper. The reasonable basis standard is not satisfied by a

return position that is merely arguable or that is merely a colorable

claim.” Id. para. (b)(3). Thus, although the reasonable basis standard

is less stringent than the “substantial authority” standard of section

6662(d)(2)(B)(i), see Treas. Reg. § 1.6662-4(d)(2), it is nonetheless an

objective criterion, based on the actual terrain of relevant legal

authorities and not on the taxpayer’s degree of knowledge or personal

circumstances. 11

The Kelleys point to the fact that on their Forms 4852 they wrote:

“I did not receive any ‘wages’ as defined in IRC Section 3401(a) and

3121(a).” Further, on the document attached to their return entitled

“Statement to Correct Incorrectly Reported 1099–DIV Information

Return,” they claimed that “[n]o dividends were received by [Mrs.

Kelley] from [Solium] which were connected with any ‘trade or business’

or otherwise constituted gains, profits, or income within the meaning of

11 These latter subjective factors are relevant to the reasonable cause

exception, discussed below.

14

[*14] relevant law.” Again, the Kelleys failed to use the prescribed form

of disclosure (i.e., Form 8275 or 8275–R).

Furthermore, as to their attempted disclosure regarding wages,

the Kelleys presented no plausible argument—whether on their return

or in this litigation—that the payments from Sanchez Oil & Gas and

Core Labs did not qualify as wages under section 3401(a) or 3121(a).

Those sections define “wages” for purposes of income tax withholding

and payroll taxes, respectively. Section 3401(a) defines “wages” as

“remuneration . . . for services performed by an employee for his

employer,” while section 3121(a) defines “wages” as “all remuneration

for employment.” Section 3401(c) provides that “the term ‘employee’

includes an officer, employee, or elected official of the United States, a

State, or any political subdivision thereof.” Section 3121(b) generally

defines the term “employment” within that section to mean services

performed within the United States or services performed outside the

United States by a U.S. citizen; section 3121(e)(2) provides that “[t]he

term ‘United States’ . . . includes the Commonwealth of Puerto Rico, the

Virgin Islands, Guam, and America Samoa.” The Kelleys imply that

because they did not work for a government entity, and because they did

not perform their work in one of the listed American territories, the

payments from Sanchez Oil & Gas and Core Labs did not fall under the

definition of “wages” in either section 3401 or section 3121.

However, section 7701(c) clarifies that “[t]he terms ‘includes’ and

‘including’ when used in a definition contained in this title [i.e., the

Code] shall not be deemed to exclude other things otherwise within the

meaning of the term defined.” Workers for private companies are

undeniably within the meaning of “the term defined” in section 3401(c)

(employee), and the 50 states of the United States are undeniably within

the meaning of “the term defined” in section 3121(e) (United

States). There is no reasonable basis for contending that, in 2017, the

Kelleys did not receive “wages” for services performed within the

“United States” as those terms are defined for purposes of income tax

withholding and payroll taxes.

Additionally, the payments the Kelleys received from Sanchez Oil

& Gas and Core Labs were “compensation for services,” which is

explicitly included in gross income by section 61(a)(1). The Kelleys do

not dispute that they performed work for Sanchez Oil & Gas and Core

Labs, nor that the payments from Sanchez Oil & Gas and Core Labs

were given in exchange for that work. Thus, those payments fall under

15

[*15] the plain meaning of “compensation for services” (a phrase that is

not specially defined in the Code or the regulations).

The Kelleys attempt to exclude the Sanchez Oil & Gas and Core

Labs payments from gross income by pointing to two alleged statutory

precedents to the current section 61: the Classification Act of 1923, ch.

265, 42 Stat. 1488, and the Revenue Act of 1938, ch. 289, § 22(a), 52 Stat.

447, 457. The definition of “compensation” in section 2 of the

Classification Act of 1923 was restricted to amounts paid to federal

government employees. However, that Act (which was repealed by the

Classification Act of 1949, ch. 782, 63 Stat. 954) by its terms provided

only for the creation of compensation schedules for certain federal

employees; it was emphatically not a tax bill. The Kelleys point out that

the Classification Act of 1923 was still in effect when the Revenue Act

of 1938 was enacted and that section 22 of the latter defined “gross

income” to “include[] gains, profits, and income derived from salaries,

wages, or compensation.” The Kelleys evidently believe that Congress

must have intended “compensation” to bear the same definition in the

Revenue Act of 1938 as it bore in the Classification Act of 1923 and that

that definition was carried forward to the current section 61 of the Code.

But this contention has no reasonable basis in the canons of

statutory construction consistently applied by the courts of this country.

As the Supreme Court has explained “many times over many years . . .

when the meaning of the statute’s terms is plain, our job is at an end.

The people are entitled to rely on the law as written, without fearing

that courts might disregard its plain terms based on some extratextual

consideration.” Bostock v. Clayton Cnty., Ga., 140 S. Ct. 1731, 1749

(2020). The term “compensation for services,” as used in both the

Revenue Act of 1938 and the current section 61, is undefined, and we

therefore accord it its plain meaning—viz, any type of payment or

remuneration given in exchange for labor. See, e.g., Compensation,

Merriam-Webster’s Online Dictionary, https://www.merriam-

webster.com/dictionary/compensation (last updated Oct. 16, 2023);

Service, Merriam-Webster’s Online Dictionary, https://www.merriam-

webster.com/dictionary/service (last visited Oct. 19, 2023). It would be

bizarre if Congress, once it gave a special definition for a term in a

particular context, were then forever barred from using that term in its

ordinary meaning.

As to the Kelleys’ attempted disclosure regarding dividends, they

apparently believe that dividends must be connected with a “trade or

business” in order to be taxable. However, this is contrary to the plain

16

[*16] text of section 61(a)(7), which includes no such qualifier. The

Kelleys never clarified on their return or in this litigation why the

definition of “trade or business” is relevant to determining whether the

Core Labs dividends are taxable. 12 Likewise, their argument that

dividends from Solium are not taxable because Solium is a “global

company” has no discernible basis in legal authority. (Moreover, the

record indicates that both Solium and Core Labs are registered to do

business in the United States and/or are doing business here.)

The Kelleys have made various other contentions resembling the

sorts of frivolous tax-protester arguments that we have dismissed on

many previous occasions. Although we could diagnose the patent faults

of these further arguments in detail, we generally decline to refute

frivolous arguments “with somber reasoning and copious citation of

precedent; to do so might suggest that these arguments have some

colorable merit.” Funk v. Commissioner, 123 T.C. 213, 217 (2004)

(quoting Crain v. Commissioner, 737 F.2d 1417, 1417 (5th Cir. 1984)).

In Wnuck v. Commissioner, 136 T.C. 498, 501–13 (2011), we explained

at length why we generally decline to refute tax-protester arguments,

and we explained the fallacies of the precise argument regarding section

3121(a) that the Kelleys advance here.

The arguments offered by the Kelleys do not constitute a

reasonable basis for their underpayment and so do not afford them the

protection of the adequate disclosure exception.

E. Reasonable Cause Exception

Section 6664(c)(1) provides a further exception to the

negligence/disregard penalty “if it is shown that there was a reasonable

cause for such portion [of the underpayment] and that the taxpayer

acted in good faith with respect to such portion.” The determination as

to whether a taxpayer acted with reasonable cause and in good faith is

made on a case-by-case basis, considering all pertinent facts and

circumstances. Treas. Reg. § 1.6664-4(b)(1). Generally, the most

important factor in determining the existence of reasonable cause is the

12 At any rate, Core Labs’ 2019 registration statement with the U.S. Securities

and Exchange Commission—a copy of which the Kelleys provided to this Court—states

in relevant part that Core Labs “is an oil-services company that helps oil and gas

companies better understand how to improve production levels and economics with

core and reservoir analysis. Additionally, the company sells a number of products

helping its customers to maximize production levels from their oil and gas assets.”

Core Labs clearly was conducting a trade or business.

17

[*17] taxpayer’s effort to ascertain his or her correct tax liability. Id.

Circumstances that may signal reasonable cause and good faith “include

an honest misunderstanding of fact or law that is reasonable in light of

all of the facts and circumstances, including the experience, knowledge,

and education of the taxpayer.” Id.

The Kelleys explained in this litigation that they conducted a

significant amount of research into current and historical tax law and

concluded that (1) labor compensation paid by private firms is not

taxable and (2) dividends reported by a company that conducts business

globally are not taxable. These erroneous conclusions conceivably could

reflect misunderstanding of the law, but they are nonetheless manifestly

unreasonable in light of the Kelleys’ educational backgrounds and

knowledge of tax law.

For instance, the Kelleys rely on congressional history to make

their case. They direct us to a portion of the 1943 Congressional Record

in which Congressman Frank Carlson, in the course of debate on the

Individual Income Tax Collection Bill of 1943, H.R. 2218, 78th Cong. (an

amended version of which was enacted as the Current Tax Payment Act

of 1943, ch. 120, 57 Stat. 126), stated the following:

The income tax is, therefore, not a tax on income as

such. It is an excise tax with respect to certain activities

and privileges which is measured by reference to the

income which they produce. The income is not the subject

of the tax: it is the basis for determining the amount of tax.

89 Cong. Rec. 2578–80 (1943) (statement of Rep. Frank Carlson).

Congressman Carlson’s remarks here are part of an extended quotation

of an “early history of the income-tax law” written by a former legislative

draftsman for the Treasury Department, which Congressman Carlson

excerpted primarily to show that an early version of the federal income

tax provided for withholding at the source. The Kelleys nonetheless

imply that Congressman Carlson intended to represent that the income

tax does not encompass income from labor in general. However, we note

first that legislative history is not to be consulted unless the statutory

text is ambiguous, which is not the case with respect to section 61(a)(1).

See Chevron, U.S.A., Inc. v. Nat. Res. Def. Council, Inc., 467 U.S. 837,

842–43 (1984). Secondly, the quoted text actually clarifies that gross

income is “the basis for determining the amount of tax.” The Kelleys

have misinterpreted the Congressman’s import. The Kelleys’ suggestion

18

[*18] that the entire U.S. legal system has been mistaken for over 100

years about the taxability of labor compensation is unreasonable.

It was likewise unreasonable for the Kelleys to draw any

conclusion about the taxability of dividends from a regulation about the

informational reporting of dividends. The Kelleys cite Treasury

Regulation § 1.6042-2(a)(2), which provides that the “person[s]” who

must file Form 1099–DIV upon paying dividends (or receiving dividends

as nominee for another person) do not include “international

organization[s].” The Kelleys note that Solium is a “global company”

and thereby conclude that it falls under the exception of Treasury

Regulation § 1.6042-2(a)(2). However, section 7701(a)(18) defines

“international organization” to mean “a public international

organization entitled to enjoy privileges, exemptions, and immunities as

an international organization under the International Organizations

Immunities Act (22 U.S.C. 288–288f).” The record shows that Solium is

not such an organization. Moreover, even if Solium were somehow

exempt from reporting the Core Labs dividends it received as nominee

for the Kelleys, that fact would have no logical bearing on the taxable

nature of the dividends in the Kelleys’ hands. To the extent the Kelleys

believe that U.S. citizens are exempt from tax on foreign-based income,

they offered no grounds for deeming that belief to be reasonable. It is

well established, and commonly known, that the United States taxes its

citizens, living and working here, on their worldwide income, from

whatever source derived, domestic or foreign. See I.R.C. § 61(a); Crow

v. Commissioner, 85 T.C. 376, 380 (1985). Furthermore, setting aside

the unreasonableness of the Kelleys’ apparent conclusion that dividends

must be connected with a “trade or business” in order to be taxable, it

defies reason to conclude that the Core Labs dividends were not

connected with Core Labs’ (very evident) trade or business. All of these

inferences and misreadings were gravely erroneous and unbefitting for

scientific professionals.

Although the Kelleys evidently exerted considerable effort to

validate their return positions, the unreasonableness of those positions

outweighs the effort. We hold that the Kelleys lack reasonable cause for

their careless disregard of the foundational rules of section 61

(regardless of the Commissioner’s burden of proof on this issue), and

they are liable for the negligence/disregard penalty.

We have considered all the arguments made by the parties, and

to the extent they are not addressed herein, we consider them moot,

irrelevant, or without merit.

19

[*19] To reflect the foregoing,

Decision will be entered for respondent.