                        T.C. Memo. 1996-235



                      UNITED STATES TAX COURT



              AMW INVESTMENTS, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 3901-94.                        Filed May 22, 1996.



     Robert E. Miller and Edith S. Thomas, for petitioner.

     Alexandra E. Nicholaides and Eric R. Skinner, for

respondent.



              MEMORANDUM FINDINGS OF FACT AND OPINION


     LARO, Judge:   AMW Investments, Inc., petitioned the Court to

redetermine the following deficiencies in Federal income taxes,

additions to tax, and accuracy-related penalties determined by

respondent:
                                 - 2 -


Taxable Year                       Additions to Tax        Penalty
   Ended                           Sec.         Sec.        Sec.
  August 31      Deficiencies    6651(a)(1)   6653(a)       6662

    1989             $656           $164      $6,615         ---
    1990           20,000          5,000        ---        $4,000
    1991           36,133          9,033        ---         7,227

Following concessions, we must decide:

     1.    Whether petitioner’s payments to an escrow account (the

Fund) are deductible as ordinary and necessary business expenses.

We hold they are not.

     2.    Whether petitioner’s payments to its sole shareholder

are deductible as interest.     We hold they are not.

     3.    Whether petitioner is liable for the additions to tax

for delinquency determined by respondent under section

6651(a)(1).    We hold it is.

     4.    Whether petitioner is liable for the addition to tax for

negligence or intentional disregard of rules or regulations

determined by respondent under section 6653(a).     We hold it is.

     5.    Whether petitioner is liable for the accuracy-related

penalties for negligence or intentional disregard of rules or

regulations determined by respondent under section 6662.       We hold

it is.

     Unless otherwise stated, section references are to the

Internal Revenue Code in effect for the years in issue.       Rule

references are to the Tax Court Rules of Practice and Procedure.

Dollar amounts are rounded to the nearest dollar.       We refer to

Harry V. Mohney as Mr. Mohney.     We refer to petitioner’s taxable
                               - 3 -


year ended August 31, 1989, as the 1988 taxable year.   We refer

to petitioner’s taxable year ended August 31, 1990, as the 1989

taxable year.   We refer to petitioner’s taxable year ended

August 31, 1991, as the 1990 taxable year.
                                - 4 -


                         FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The stipulations of facts and attached exhibits are incorporated

herein by this reference.   Petitioner's principal place of

business was in Durand, Michigan, when it petitioned the Court.

Petitioner filed a Form 1120, U.S. Corporation Income Tax Return,

for each year in issue using a fiscal year ended August 31 and an

accrual method of accounting.   The 1988, 1989, and 1990

Forms 1120 were filed on August 15, 1991, March 6, 1992, and

July 17, 1992, respectively.

     Petitioner was incorporated on August 24, 1977, to purchase

real property and to lease this property primarily to businesses

engaged in adult entertainment.   From its incorporation through

August 31, 1988, petitioner was a wholly owned subsidiary of

Dynamic Industries, Ltd. (Dynamic).     During the subject years,

Mr. Mohney owned all of petitioner's voting stock, and he was its

president.   At all times relevant herein, petitioner was a member

of an organization of over 50 businesses that were engaged in the

adult entertainment industry.   All of these businesses were

wholly or partially owned by Mr. Mohney, either directly or

indirectly through various trusts.

     In 1966, Mr. Mohney had started acquiring (and operating as

sole proprietorships) numerous enterprises that were primarily

engaged in adult entertainment.   The assets of these enterprises
                               - 5 -


included theaters, bookstores, peep machines, wholesale novelty

stores, film distributorships, and "showgirl" clubs. As

Mr. Mohney's business dealings evolved over time and he began to

gain greater notoriety, his reputation as a proprietor of adult

entertainment establishments preceded him and affected the future

expansion of his business operations into new communities.

Mr. Mohney decided to purchase property through nominees due to

his concerns that he would encounter legal problems if he

purchased property in his own name.    For example, his mother was

the nominee when he purchased a movie theater in Mishawaka,

Indiana (Mishawaka property), on December 1, 1969, for $45,000.

Mr. Mohney paid for the Mishawaka property by giving the seller

$13,500 in cash and agreeing to pay the balance (with interest

at 7 percent) through monthly payments of at least $500.

     On October 31, 1970, Mr. Mohney purchased a drive-in theater

located in Clarksville, Indiana (Clarksville property), for

$120,000, signing a $114,500 promissory note (Clarksville note).

From 1970 to the time that he transferred the Clarksville

property to petitioner, Mr. Mohney made payments on the

Clarksville note.

     In the early 1970's, Mr. Mohney organized each aspect of his

business as a separate corporation.    Mr. Mohney also established

five domestic trusts, of which he and his four children were

beneficiaries.   Each of these trusts owned an interest in another
                               - 6 -


domestic trust, the Durand Trust, which owned all the stock of

Dynamic, which owned many of Mr. Mohney's operating companies.

     Shortly after petitioner's incorporation, Mr. Mohney

transferred to it the Mishawaka property and the Clarksville

property.1   The transfer was not negotiated, and the deeds on the

Clarksville property and the Mishawaka property were recorded on

September 5, 1978 and March 21, 1980, respectively.   In

connection with the transfer, petitioner assumed liability on the

Clarksville note, the principal of which was then $34,350.

Petitioner also issued Mr. Mohney a promissory note for the

Clarksville property (Second Clarksville note).2   The Second

Clarksville note stated that petitioner was to pay Mr. Mohney

$120,000 on or before November 3, 1982.   It set forth an interest

rate of 10 percent, and it was signed by petitioner's then

president.   Petitioner made no payments of principal or interest

to Mr. Mohney during the years 1977 through 1988 on the Second

Clarksville note, and Mr. Mohney did not pursue collection of the

note.


     1
       Mr. Mohney's 1977 Federal income tax return did not report
either transfer as a sale.
     2
       Petitioner also alleges that it issued a $45,000 note to
Mr. Mohney in connection with the transfer of the Mishawaka
property. Petitioner did not produce any such note at trial, and
no payments were made on the alleged note before 1989. The
record does not indicate that Mr. Mohney attempted to pursue
collection of any obligation from petitioner to him with respect
to the Mishawaka property.
                               - 7 -


     Around 1981, Mr. Mohney asked Janet Dingeman Fournier

(Ms. Fournier) to serve as petitioner's president.    Ms. Fournier

served in this capacity until 1988.    As petitioner’s president,

Ms. Fournier had no meaningful responsibility other than to sign

tax returns and other documents on petitioner’s behalf.    Aside

from Ms. Fournier, petitioner had no employees.    Apart from the

use of company cars, Ms. Fournier received no compensation from

petitioner.

     From 1974 through 1993, Ms. Fournier was also an employee of

Modern Bookkeeping Services, Inc. (MBS).    Mr. Mohney had formed

MBS to handle and centralize the bookkeeping and tax preparation

aspects of his businesses.   Elizabeth L. Scribner (Ms. Scribner)

was MBS’ president and general manager.    Thomas H. Tompkins

(Mr. Tompkins) was MBS’ accountant, and he was responsible for

preparing petitioner's Federal income returns before the subject

years.   Lee J. Klein (Mr. Klein) provided legal services to MBS

and MBS’ clients.

     Petitioner's financial affairs were maintained at MBS’

office in Durand, Michigan, and MBS maintained all of

petitioner's files, including its bank accounts, cash receipts

journals, cash disbursements journals, and lease files.    MBS paid

petitioner's bills on behalf of it, and MBS prepared petitioner’s

financial statements.   MBS charged petitioner a fee of $1,000

per month for its bookkeeping services.
                               - 8 -


     In 1984, Federal agents, investigating a pattern of arsons

at adult theaters, searched MBS’ premises and seized books and

records which included those of petitioner.   In connection with

this search, a grand jury, on September 9, 1988, handed down a

seven-count indictment against Mr. Mohney, Ms. Scribner,

Mr. Tompkins, and Mr. Klein (collectively referred to as the

Defendants) for various criminal tax violations.   The indictment

generally charged that Mr. Mohney, through separate corporate tax

returns, concealed his ownership of several adult-oriented

businesses and filed false personal tax returns.   The other

defendants, who were all employees of MBS, were charged only in

count I of the indictment.   Count I charged the Defendants with

conspiracy to defraud the Government through the concealment of

ownership of the adult-oriented businesses on the tax returns, in

violation of 18 U.S.C. sec. 371.   The remaining counts charged

Mr. Mohney with filing false individual income tax returns for

the 1981, 1982, and 1983 taxable years (see sec. 7206(1)), and

with aiding and assisting in the filing of false corporate income

tax returns on behalf of Otis Mohney, Inc./International

Amusements, Ltd. (see sec. 7206(2)).   The remaining counts

stemmed from the failure of International Amusements, Ltd., to

report income it earned and diverted to Mr. Mohney for his

personal benefit.   All of the Defendants except Mr. Klein pleaded
                                - 9 -


guilty to the conspiracy charge.3    Mr. Mohney was subsequently

convicted of the remaining charges, and his conviction was

affirmed on appeal.    United States v. Mohney, 949 F.2d 1397

(6th Cir. 1991).

     Petitioner and all of its related corporations jointly

agreed to pay the legal fees of any officer, employee, or

business associate called as a witness before the grand jury or

any proceeding stemming therefrom.      The legal expenses that were

claimed by petitioner (and that are in issue herein) were the

amounts that it paid to the Fund, which was an escrow account

that was established by MBS in 1985 to administer this agreement.

The Fund was a separate, interest-bearing account.       MBS

maintained the Fund’s cash receipts journal, cash disbursements

journal, and check book registers.      There were no written

agreements prepared and signed contemporaneous to the

establishment of the Fund.

     Petitioner made monthly payments of $200 to the Fund.

During petitioner’s 1985 through 1990 taxable years, petitioner

made payments to the Fund totaling $11,400.      During its 1989

taxable year, petitioner paid $1,948 to the Fund.      The amounts

paid to the Fund were recorded by petitioner in a prepaid asset

account and were not deducted by petitioner until the amounts



     3
         Mr. Klein was later convicted of this charge.
                                - 10 -


were spent by the Fund.    As of September 1990, a total of

$1,333,350 had been paid to the Fund by the various corporations.

      David Shindel (Mr. Shindel) is a certified public accountant

who was retained by Mr. Klein in 1987, on behalf of MBS and

several of its clients, to review their corporate books and

records for compliance with accounting practice and tax law.

Upon reviewing petitioner's books, Mr. Shindel noticed the Second

Clarksville note.     Mr. Shindel brought this note to the attention

of Mr. Mohney, recommending that it be satisfied with accrued

interest.   Mr. Shindel also recommended that the “note” on the

Mishawaka property be satisfied with accrued interest.    During

1989 and 1990, petitioner paid Mr. Mohney the balance due on the

Mishawaka and Clarksville properties plus accrued interest.

Petitioner deducted $55,000 and $105,000 as interest on its 1990

and 1991 returns respectively.

      Mr. Shindel prepared all of petitioner’s Federal tax returns

that are in issue herein.

                                OPINION

1.   Legal Expenses

      We must decide whether petitioner may deduct its

contributions to the Fund as ordinary and necessary business

expenses under section 162(a).    Petitioner argues that it may.

Petitioner contends that these contributions were tied directly

to its business because the contributions were made to protect or
                              - 11 -


promote its business interest.   Respondent argues that the Fund

paid the Defendants’ personal expenses.   Petitioner bears the

burden of proof.   Rule 142(a); Welch v. Helvering, 290 U.S. 111,

115 (1933).

     We agree with respondent that the contributions are not

deductible under section 162(a).   Generally, a taxpayer may not

deduct an expense of another person, Deputy v. duPont, 308 U.S.

488 (1940); J. Cordon Turnbull, Inc. v. Commissioner, 41 T.C.

358, 378 (1963), affd. 373 F.2d 87 (5th Cir. 1967); Royal

Cotton Mill Co. v. Commissioner, 29 T.C. 761, 788 (1958), and may

not deduct expenses which are personal in nature, sec. 262;

Johnson v. Commissioner, 72 T.C. 340, 348 (1979).     An exception

is found where the taxpayer pays for legal services rendered to

another person, in order to protect or promote the taxpayer’s

business interests.   Commissioner v. Tellier, 383 U.S. 687 (1966)

(corporation could deduct legal fees of another when the related

litigation threatened the corporation’s existence);

Commissioner v. Heininger, 320 U.S. 467, 475 (1943); Gould v.

Commissioner, 64 T.C. 132, 134-135 (1975); Lorhrke v.

Commissioner, 48 T.C. 679, 684-685 (1967); Pepper v.

Commissioner, 36 T.C. 886, 895 (1961); Catholic News Publishing

Co. v. Commissioner, 10 T.C. 73, 77 (1948).   The origin of the

claim that gave rise to the legal fees, rather than the

consequences of the underlying action, must be evaluated to
                              - 12 -


ascertain whether the fees are business or personal in nature.

United States v. Gilmore, 372 U.S. 39 (1963).   The fact that

legal fees are paid by a taxpayer on behalf of another person's

criminal defense will not foreclose a deduction by the taxpayer

when the alleged criminal activity relates to the taxpayer’s

trade or business.   See Commissioner v. Tellier, supra;

Conforte v. Commissioner, 74 T.C. 1160, 1189-1190 (1980), affd,

in part and revd. in part 693 F.2d 587 (9th Cir. 1982);

Johnson v. Commissioner, supra at 347-348 (1979); cf.

Pantages Theatre Co. v. Welch, 71 F.2d 68 (9th Cir. 1934)

(corporation could not deduct legal expenses paid to defend its

president and majority shareholder in defense of charges that he

raped a prospective client of the corporation); Sturdivant v.

Commissioner, 15 T.C. 880 (1950) (partnership could not deduct

legal expenses paid to defend two of its partners and an employee

charged with the murder of a business associate); Price v.

Commissioner, T.C. Memo. 1973-65 (taxpayer could not deduct

legal fees incurred by management consultant for criminal defense

of the fraudulent sale of securities because consultant was not

in the trade or business of selling securities).

     In Lohrke v. Commissioner, supra at 688, the Court adopted a

two prong test for determining when a taxpayer may deduct the

legal expenses of another.   First, the Court looked to the

purpose or motive that caused the taxpayer to pay the other
                              - 13 -


person’s expense.   Deductibility will not be denied when the

expense was incurred primarily for the payor’s business, and any

personal benefit conferred on the other party was merely

incidental to the payor’s objective.    Second, the Court

considered whether the expenditure was an ordinary and necessary

expense of the taxpayer's business.    We ask ourselves:    “Was the

expenditure an appropriate expense to further or promote the

payor’s trade or business”?   Id.

     With respect to the first prong, petitioner alleges that it

stood to suffer direct and proximate adverse effects to its

business as a result of the criminal investigation.    Petitioner

argues that its contributions to the Fund were related to

petitioner's business in that its records were seized during the

search of MBS, its President was called to testify about its tax

returns, its relationship to Mr. Mohney was close and direct, and

it had a similar relationship with the other enterprises

connected to the grand jury hearing.    Petitioner contends that

it, not Mr. Mohney, was the primary beneficiary of the payments

to the Fund, because the grand jury investigation and subsequent

criminal proceedings threatened its corporate existence.

Petitioner contends that its contributions to the Fund were

necessary to defend itself in proceedings in which its own tax

and accounting practices may have been called into question.
                              - 14 -


     We find petitioner’s arguments unpersuasive.    Although legal

expenses related to the determination of Federal income taxes are

deductible under section 162, see, e.g., Greene Motor Co. v.

Commissioner, 5 T.C. 314 (1945), and a corporate taxpayer may

deduct its expense of defending against criminal tax charges,

see, e.g., Shapiro v. Commissioner, 278 F.2d 556 (7th Cir. 1960),

affg. International Trading Co. v. Commissioner, T.C. Memo.

1958-104, petitioner has not persuaded us that the legal expenses

in issue stem from a clear, direct, and proximate adverse effect

upon it or its business.   Petitioner was not a defendant in the

criminal proceeding, and it was not named in the indictment.

Rather, the indictment and the resulting prosecutions were

limited to Mr. Mohney and the other Defendants.     The charges did

not arise from petitioner's business of leasing real property,

and petitioner was not under the threat of criminal prosecution

or forfeiture.   See O'Malley v. Commissioner, 91 T.C. 352, 359

(1988); Matula v. Commissioner, 40 T.C. 914, 920 (1963);

Sachs v. Commissioner, 32 T.C. 815, 820 (1959), affd. 277 F.2d

879 (8th Cir. 1960).

     While there is a possibility that some of the claimed

expenditures may have had some benefit to petitioner’s business,

petitioner has not shown this to be true.   Put simply, petitioner
                                - 15 -


has failed to carry its burden of proof.4    Given the fact that

the charges stemmed from the personal conduct of the Defendants,

we are simply not persuaded that any of the payments made by

petitioner to the Fund were petitioner's business expenses.5

2.   Interest Expense

     Respondent disallowed petitioner's $160,000 interest

deduction on the ground that the subject properties were

contributed to petitioner's capital.     Petitioner argues that it

may deduct the interest because it acquired the Mishawaka

property and the Clarksville property from Mr. Mohney.

     An accrual method taxpayer may deduct interest that has

accrued within the taxable year on debt.    Sec. 163(a).   The term

"debt" connotes an existing, unconditional, and legally

enforceable obligation for the payment of money.     First Natl. Co.

v. Commissioner, 289 F.2d 861 (6th Cir. 1961), revg. and

remanding 32 T.C. 798 (1959).    Whether interest has accrued on

debt is a factual determination.    Roth Steel Tube Co. v.


     4
       Petitioner contends that a criminal conviction against
Mr. Mohney would damage petitioner because he was indispensable
to it. We are unpersuaded. Petitioner has not shown that it
would have been inoperable as a result of Mr. Mohney's criminal
conviction. Petitioner has also presented no evidence that it
suffered any business decline or any damage to its business
relationships as a result of Mr. Mohney's prosecution and/or
conviction.
     5
       We also are not convinced that the expenses were ordinary
and necessary. Suffice it to say that petitioner has not proven
that they were.
                              - 16 -


Commissioner, 800 F.2d 625 (6th Cir. 1986), affg. T.C. Memo.

1985-58; Smith v. Commissioner, 370 F.2d 178, 180 (6th Cir.

1966), affg. T.C. Memo. 1964-278; see Burrill v. Commissioner,

93 T.C. 643, 669 (1989).   Courts refer to numerous factors to

determine whether a payment is for debt or equity.    The Court of

Appeals for the Sixth Circuit, to which appeal in this case lies,

refers primarily to eleven factors.    See Roth Steel Tube Co. v.

Commissioner, supra at 630.   These factors are:   (1) The names

given to the instruments evidencing the indebtedness; (2) the

presence or absence of a fixed maturity date and schedule of

payments; (3) the presence or absence of a fixed interest rate

and interest payments; (4) the source of repayments; (5) the

adequacy or inadequacy of capitalization; (6) the identity of

interest between the creditor and stockholder; (7) the security

for the advances; (8) the corporation's ability to obtain

financing from outside lending institutions; (9) the extent to

which the advances were subordinated to the claims of outside

creditors; (10) the extent to which the advances were used to

acquire capital assets; and (11) the presence or absence of a

sinking fund to provide repayment.     Id.; Raymond v. United

States, 511 F.2d 185, 190-191 (6th Cir. 1975); Austin Village,

Inc. v. United States, 432 F.2d 741, 745 (6th Cir. 1970);

Berthold v. Commissioner, 404 F.2d 119, 122 (6th Cir. 1968),

affg. T.C. Memo. 1967-102; Smith v. Commissioner, supra at 180.
                                 - 17 -


In distinguishing debt from equity, the economic substance of the

transaction prevails over form.      Byerlite Corp. v. Williams,

286 F.2d 285, 291 (6th Cir. 1960).

     We now analyze and weigh all relevant facts to determine

whether petitioner and Mr. Mohney intended to create a debt, and

whether their intention comported with the economic reality of a

debtor-creditor relationship.     Petitioner carries the burden of

establishing that the subject transfers generated debt rather

than equity.   Rule 142(a).

     i.   Name of Certificate

     We look to the name of the certificate evidencing purported

debt to determine the “debt’s” true label.       The issuance of a

note weighs toward debt.      Estate of Mixon v. United States,

464 F.2d 394, 403 (5th Cir. 1972).        The mere fact that a taxpayer

issues a note, however, is not dispositive of debt.       An unsecured

note, with no payments made thereon until long after the due

date, weighs toward equity.      Stinnett's Pontiac Serv. v.

Commissioner, 730 F.2d 634, 638 (11th Cir. 1984), affg. T.C.

Memo. 1982-314.

     Although petitioner issued the Second Clarksville note to

Mr. Mohney, we give this fact little weight.       The record shows

that the transfer of the subject properties to petitioner

occurred in 1977, yet the related deeds were not recorded until

sometime thereafter.   We also find that Mr. Mohney's
                               - 18 -


1977 individual income tax return did not report a sale of either

of the properties, and petitioner did not make any payments on

either of the properties until 1989.    Petitioner focuses on the

fact that it recorded debt on its books in connection with the

transfer.   We are not impressed.   Under the facts at hand,

petitioner’s accounting entry lends little (if any) support for a

finding of debt.   See Raymond v. United States, supra at 191.

This is particularly true, given the fact that the parties did

not deal at arm's length.

     This factor is neutral.

     ii.    Fixed Maturity Date

     The presence of a fixed maturity date weighs toward debt,

but is not dispositive of a debtor-creditor relationship.

American Offshore, Inc. v. Commissioner, 97 T.C. 579, 602 (1991).

The presence of a fixed maturity date may be offset by other

facts in the record.

     Although the Second Clarksville note bore a maturity date of

November 3, 1982, petitioner made no payments on this note until

1989.   Petitioner also made no payments for the Mishawaka

property until 1989.   The timing of these payments indicates that

a debtor-creditor relationship was not contemplated by petitioner

and Mr. Mohney.    The presence of the fixed maturity date on the

Second Clarksville note is further downplayed by the fact that

Mr. Mohney did not pursue collection or inquire as to payment.
                                  - 19 -


Mr. Mohney testified that he simply forgot about the transaction

and the debt owed to him.      We find this testimony unbelievable,

and, even assuming arguendo that it was credible (which it was

not), we find this testimony to be uncharacteristic of a bona

fide creditor.

     This factor weighs toward equity.

     iii.     Interest Rate and Payments

     The presence of a fixed rate of interest and actual interest

payments weigh toward debt.      The absence of payments in

accordance with the terms of a debt instrument weighs toward

equity.     Id. at 605.

     Although the Clarksville note bore an interest rate of

10 percent, petitioner made no principal or interest payments to

Mr. Mohney until 12 years after the transfer.      Petitioner also

made no principal or interest payments to Mr. Mohney on the

Mishawaka transfer until 12 years after the transfer.

     This factor weighs toward equity.

     iv.     Repayment

     Repayment that is dependent upon corporate earnings weighs

toward equity.    Repayment that is not dependent on earnings

weighs toward debt.       Roth Steel Tube Co. v. Commissioner, supra

at 632; Lane v. United States, 742 F.2d 1311, 1314 (11th Cir.

1984); American Offshore, Inc. v. Commissioner, supra at 602.
                              - 20 -


     Petitioner's ability to make payments on the subject

properties depended primarily (if not solely) on the rental

income from the properties.   Immediate payment of the purported

debt also does not seem to have been available from petitioner's

existing assets which consisted primarily (if not entirely) of

the subject properties.

     This factor weighs toward equity.

     v.    Capitalization

     Thin or inadequate capitalization weighs toward equity.

Roth Steel Tube Co. v. Commissioner, 800 F.2d at 632.

     The record indicates that petitioner did not have meaningful

equity either before or at the time Mr. Mohney transferred the

subject properties to it.

     This factor weighs toward equity.

     vi.   Identity of Interest

     Advances made by stockholders in proportion to their

respective stock ownership weigh toward equity.   A sharply

disproportionate ratio between a stockholder’s ownership

percentage in the corporation and the debt owing to the

stockholder by the corporation generally weighs toward debt.

Id. at 630; Estate of Mixon v. United States, supra at 409;

American Offshore, Inc. v. Commissioner, supra at 604.

Mr. Mohney owned the subject properties immediately before their
                                - 21 -


transfer, and he effectively owned 100 percent of petitioner’s

equity at the time of the transfer.

     This factor weighs toward equity.

     vii.     Presence or Absence of Security

     The absence of security for purported debt weighs toward

equity.     Roth Steel Tube Co. v. Commissioner, supra at 632;

Lane v. United States, supra at 1317; Raymond v. United States,

511 F.2d at 191; Austin Village, Inc. v. United States, 432 F.2d

at 745.

     Mr. Mohney did not receive security for his transfer of the

subject properties to petitioner.

     This factor weighs toward equity.

     viii.     Inability to Obtain Financing

     The question of whether a transferee could have obtained

comparable financing is relevant in measuring the economic

reality of a transfer.     Estate of Mixon v. United States, 464

F.2d at 410; Nassau Lens Co. v. Commissioner, 308 F.2d 39, 47

(2d Cir. 1962), remanding 35 T.C. 268 (1960).    Evidence that the

taxpayer could not obtain loans from independent sources weighs

toward equity.     Calumet Indus., Inc. v. Commissioner, 95 T.C.

257, 287 (1990).    We look to whether the terms of the purported

debt were a "patent distortion of what would normally have been

available" to the debtor in an arm’s-length transaction.    See
                               - 22 -


Litton Business Sys., Inc. v. Commissioner, 61 T.C. 367, 379

(1973).

     Petitioner presented no evidence on whether it could have

obtained financing from an unrelated party at the time of the

transfer, or on the order of priority of its debts.    Given the

fact, however, that the purported debts were completely unsecured

and that the subject properties were petitioner’s main asset, we

are left unpersuaded that an unrelated third party would have

entered into financing with petitioner under the terms that it

alleges were entered into between it and Mr. Mohney.

     This factor weighs toward equity.

     ix.     Subordination

     Subordination of purported debt to the claims of other

creditors weighs towards equity.    Roth Steel Tube Co. v.

Commissioner, supra at 631-632; Stinnett's Pontiac Serv. Inc. v.

Commissioner, supra at 639; Raymond v. United States, supra at

191; Austin Village, Inc. v. United States, supra at 745.

     Petitioner presented no evidence on the order of priority of

its debts.

     This factor weighs toward equity.

     x.    Use of Funds

     The transfer of funds from a shareholder to a corporation in

order to meet the corporation’s daily business needs weighs

toward debt.    The transfer of funds from a shareholder to a
                               - 23 -


corporation in order to purchase capital assets weighs toward

equity.    Roth Steel Tube Co. v. Commissioner, supra at 632;

Stinnett's Pontiac Serv. v. Commissioner, supra at 640;

Raymond v. United States, supra at 191.

     The subject properties were petitioner’s initial and primary

assets, and the purported notes represented a long-term

commitment that was payable mainly from the future rental income

from the properties.    We also find relevant that Mr. Mohney was

willing to go unpaid for many years so that petitioner could

continue to enjoy the advantage of uninterrupted ownership of the

properties.

     This factor weighs toward equity.

     xi.    Presence or Absence of a Sinking Fund

     The failure to establish a sinking fund for repayment weighs

toward equity.    Roth Steel Tube Co. v. Commissioner, supra at

632; Lane v. United States, 742 F.2d at 1317; Raymond v. United

States, supra at 191; Austin Village, Inc. v. United States,

supra at 745.

     The record does not indicate that petitioner established a

sinking fund for the repayment of the purported notes.    To the

contrary, it appears that repayment was to come solely from

petitioner's earnings.

     This factor weighs toward equity.
                                - 24 -


     xii.   Conclusion

     Based on the above, we conclude that petitioner may not

deduct the $160,000 that it claimed as an interest expense paid

to Mr. Mohney.6

3.   Section 6651

     Respondent determined additions to tax under section

6651(a)(1), asserting that petitioner failed to file timely

Federal income tax returns.    In order to avoid this addition to

tax, petitioner must prove that its failure to file timely was:

(1) Due to reasonable cause and (2) not due to willful neglect.

Sec. 6651(a); Rule 142(a); United States v. Boyle, 469 U.S. 241,

245 (1985); Catalano v. Commissioner, 81 T.C. 8 (1983).

A failure to file timely is due to reasonable cause if the

taxpayer exercised ordinary business care and prudence and,

nevertheless, was unable to file the return within the prescribed

time.    Sec. 301.6651-1(c)(1), Proced. & Admin. Regs.    Willful

neglect means a conscious, intentional failure or reckless

indifference.     United States v. Boyle, supra at 245.



     6
       Even if we were to assume arguendo that Mr. Mohney and
petitioner had intended to establish a debtor-creditor
relationship ab initio, the record reveals that the character of
that debt, as debt, vanished before the subject years and was
equity during those years. See Green Leaf Ventures, Inc. v.
Commissioner, T.C. Memo. 1995-155; Frazier v. Commissioner,
T.C. Memo. 1975-220.
                               - 25 -


     Petitioner filed its 1988 and 1989 Forms 1120 almost 2 years

past the due dates, and petitioner filed its 1990 Form 1120 more

than 6 months late.    Petitioner has not argued that it had

reasonable cause for these late filings.    Given the additional

fact that the record does not otherwise establish reasonable

cause for petitioner’s late filings, we sustain respondent on

this issue.

4.   Section 6653(a)

      Respondent determined that petitioner was liable for an

addition to its 1988 tax under section 6653(a).    Section 6653(a)

applies when any part of an underpayment of tax is due to

negligence or intentional disregard of rules or regulations.

For petitioner’s 1988 taxable year, section 6653(a)(1) imposes an

addition to tax equal to 5 percent of the entire underpayment if

any portion of the underpayment is attributable to negligence.

Negligence connotes the lack of due care or failure to do what a

reasonable and ordinarily prudent person would do under the

circumstances.   Neely v. Commissioner, 85 T.C. 934, 947 (1985).

Given the fact that respondent determined that petitioner was

negligent, petitioner must prove her wrong.    Rule 142(a); Bixby

v. Commissioner, 58 T.C. 757, 791-792 (1972).

      Petitioner contends that it was unsophisticated about tax

laws, and that it relied on MBS to provide Mr. Shindel with
                                - 26 -


enough information to ensure proper compliance with those laws.

Although MBS failed to do its job properly, petitioner concludes,

petitioner’s reliance on them to do a proper job was consistent

with ordinary business care and prudence under the circumstances.

     We do not agree.   Reasonable reliance on a tax adviser is

consistent with ordinary business care and prudence only in

certain cases.   In those cases, the taxpayer must establish that:

(1) The adviser had sufficient expertise to justify reliance,

(2) the taxpayer provided necessary and accurate information to

the adviser, and (3) the taxpayer actually relied in good faith

on the adviser’s judgment.   See, e.g., Ellwest Stereo Theatres of

Memphis, Inc. v. Commissioner, T.C. Memo. 1995-610.     Mr. Shindel

prepared and signed petitioner’s tax returns for the years in

issue.   His experience and qualifications were sufficient to

warrant reliance upon his judgement.     Although it appears that

petitioner has met the first prong, we find that it has failed to

satisfy the remaining prongs.    To the contrary, the record

indicates that petitioner did not exercise due care, and it

failed to do what a reasonable and ordinarily prudent person

would have done under the circumstances.     Petitioner claimed

erroneous deductions for legal expenses and interest expenses.

Petitioner also filed its tax returns untimely.     In the latter

regard, petitioner knew it was required to file timely a Federal
                                - 27 -


income tax return for each year in issue, but it neglected to do

so.   Given the fact that taxpayers have a statutory duty to file

timely income tax returns, we believe that a reasonable and

ordinarily prudent person would have complied with the statutory

duty to file timely such a return.       We also believe that breach

of this duty is evidence of negligence.       Condor Intl., Inc., v.

Commissioner, 98 T.C. 203, 225 (1992), affd. in part and revd. in

part 78 F.3d 1355 (9th Cir. 1996); Emmons v. Commissioner,

92 T.C. 342, 349 (1989), affd. 898 F.2d 50 (5th Cir. 1990).      The

fact that petitioner was negligent in the instant case is also

supported by the fact that petitioner erroneously claimed

deductions for the interest expenses and its shareholder’s legal

fees.    See Condor Intl. Inc., v. Commissioner, supra at 225;

Emmons v. Commissioner, supra at 349.       We hold for respondent on

this issue.

5.    Section 6662

      Respondent also determined that petitioner's underpayments

of Federal income taxes for the 1989 and 1990 taxable years were

due to negligence, and, accordingly, that they were subject to

section 6662(a).     Section 6662(a) imposes an accuracy-related

penalty equal to 20 percent of the portion of the underpayment

that is attributable to negligence.      See also sec. 6662(b)(1).
                              - 28 -


     For purposes of section 6662(a), "negligence” includes a

failure to make a reasonable attempt to comply with the Internal

Revenue Code, and "disregard" includes careless, reckless, or

intentional disregard.   Sec. 6662(c); sec. 1.6662-3(b)(1),

Income Tax Regs.   Section 6664(c) provides a reasonable cause

exception to the accuracy-related penalty under section 6662.

     Petitioner argues that it is within the exception under

section 6664(c).   Petitioner argues that it held an honest and

good faith belief about the deductibility of its payments for

legal fees and interest expense based on its reasonable reliance

on MBS to ensure tax compliance.   For the same reasons discussed

above, we disagree.   We sustain respondent on this issue.

     We have considered all of petitioner's arguments for

contrary holdings and, to the extent not addressed above, find

them to be without merit.

     To reflect concessions by respondent,

                                         Decision will be entered

                                    under Rule 155.
