2. Based on the disallowance of the New York subtraction claimed for interest on U. S. government bonds, the Division of Taxation ("Division") issued to petitioners an assessment asserting total tax due in the amount of $7,054.88, less total tax withheld of $5,999.00, for a balance due of $1,055.88. Based on correspondence submitted by petitioners, the assessment was canceled. Petitioners’ correspondence submitted in protest of the assessment is not part of the record. Subsequently, petitioners received a refund of $5,713.00 plus interest.

3. A field audit was commenced on April ii, 1995. Review of the auditor’s entries in the Tax Field Audit Record ("audit record") reveals that she made a number of requests to petitioners for copies of their 1992 and 1993 Federal personal income tax returns ("Form 1040") along with all pages of Schedule K-Is for the partnerships listed on the 1992 and 1993 Schedule Fs. However, because petitioners were uncooperative and supplied limited information, the auditor bad to request information from third-party sources.3 None of the auditor’s requests focused on the other income reported as New York source income.

4. The audit of the year 1992 was discontinued after review of the limited information available. The auditor reviewed the 1993 Form 1040, the 1993 Form IT-203 and the K-i from Steinhardt Partners and determined that petitioners had incorrectly reported Mrs. Moore’s distributive share of partnership income from Steinhardt Partners on both their Federal and State returns. (emphasis added) A copy of the 1993 Steinhardt Partners K-i and its supporting schedules are part of the record. Line 7 of this K-1 lists Other Income of $2,770,838.15, which is broken down into the following categories: Interest on US Obligations of $339,613.00, Other Interest Income of $771,944.33, Dividend Income of $30,102.73, Other Expenses of $202,658.42, LRC Section 988 Income (foreign currencies) of $1,083,003.07, Other Income of $39,727.08, Net Long-Term Capital Gain of $15,137.67, Net Short-Term Capital Gain of $695,282.52 and Net Section 1256 Losses of $1,313.83.

5. The auditor prepared and sent petitioners a total of three statements of personal income tax audit changes. The majority of the audit adjustments made in the three statements pertained to accounting for various items included in Mrs. Moore’s distributive share of the Steinhardt Partners income. Subsequent to the issuance of the first statement, petitioners submitted additional information which formed the basis of the second statement. As a result of the correspondence submitted by petitioners challenging the second statement, the third and final Statement of Personal Income Tax Audit Changes was issued on August 30, 1996. In that Statement of Personal Income Tax Audit Changes, the auditor made the following adjustments: increased the Federal adjusted gross income by $2,281,859.22 to a total of $2,739,O94.22; increased the Federal itemized deductions by $876,026.61; increased the New York State addition modification by $239,991.14; decreased the New York State subtraction modification by $136,516.00 and increased the New York State allowable itemized deductions by $433,014.81. As a result of the audit adjustments, petitioners’ New York State taxable income was determined to be $2,190,814.56 and the base New York State tax on that amount was determined to be $172,526.65. The auditor then multiplied the New York State income percentage of 3.04%4 by the base New York State tax of $172,526.65, determining the recomputed New York State tax to be $5,244.81. No additional New York City earnings tax was determined to be due. The statement issued showed a corrected tax liability for New York State in the amount of $5,244.81 and for New York City in the amount of $286.00. Penalty for negligence under Tax Law § 685(b), equal to 5% of the additional tax due, plus interest were added to the additional tax asserted as due.

In the cover letter which accompanied the third statement of audit changes, the auditor addressed the issues raised in petitioners’ letter challenging the second statement of audit changes and explained the slight revisions to the previous computation of petitioners’ Federal and New York taxable income which were reflected in the final statement. The auditor also indicated that any applicable revisions would be

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