                         T.C. Memo. 1997-371



                       UNITED STATES TAX COURT



     WILLIAM L. MCCURLEY AND VICTORIA J. MCCURLEY, ET AL.,1
  Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket Nos. 10499-94, 10500-94            Filed August 14, 1997.
                  6557-95.



     Joseph Warren III and C. Ralph Kinsey, Jr., for

petitioners.

     Ross A. Rowley and Paul G. Topolka, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION




     1
        Cases of the following petitioners are consolidated
herewith: Robert D. Hall and Gayle E. Hall, docket No. 10500-94;
William L. McCurley and Victoria J. McCurley, docket No. 6557-95.
                               - 2 -

     FOLEY, Judge:   Respondent determined the following

deficiencies, addition to tax, and accuracy-related penalties

relating to petitioners' Federal income taxes:

William L. McCurley and Victoria J. McCurley, docket No. 10499-94

                                               Addition to Tax
           Year           Deficiency              Sec. 6661

           1988            $43,612                  $10,903
           1989              9,900                     --
           1990              5,600                     --


Robert D. Hall and Gayle E. Hall, docket No. 10500-94

                                                    Penalty
           Year           Deficiency               Sec. 6662

           1989            $11,247                  $2,249
           1990             11,200                   2,240
           1991             18,468                   3,694


William L. McCurley and Victoria J. McCurley, docket No. 6557-95

                                                    Penalty
           Year           Deficiency               Sec. 6662

           1991            $12,664                  $2,533
           1992              4,473                     895

Unless otherwise indicated, all section references are to the

Internal Revenue Code in effect for the years in issue.

     The issues for decision are as follows:

     1.   Whether certain payments made by a corporation to

petitioners are loans or constructive dividends.    We hold that

they are constructive dividends.

     2.   Whether petitioners, pursuant to section 6662(a), are

liable for accuracy-related penalties for negligence in the
                                - 3 -

amounts and for the years set forth above.    We hold that they are

liable with one exception stated herein.



     3.   Whether petitioners William and Victoria McCurley,

pursuant to section 6661(a), are liable for an addition to tax

for a substantial understatement with respect to their 1988

return.   We hold that they are liable.

                          FINDINGS OF FACT

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

William and Victoria McCurley, husband and wife, resided in

Kennewick, Washington, at the time their petitions were filed.

Robert and Gayle Hall, husband and wife, resided in Yakima,

Washington, at the time their petition was filed.   Messrs.

McCurley and Hall each owned automobile dealerships at all

relevant times.    Mr. McCurley owned 100 percent of Bill McCurley

Chevrolet, Inc., and McCurley Pontiac, Inc.   Mr. Hall owned 100

percent of Sunfair Chevrolet, Inc., and 75 percent of Greenway

Auto Plaza, Inc.

     Each dealership offered financing to prospective customers.

The dealership, as an agent for an insurance company, offered

credit life and/or credit health insurance policies to customers

who financed their purchases through the dealership.   The

dealership retained as compensation a portion of the premium due.

The policies provided that the insurer would make payments on the

dealership loan in the event the insured became disabled and
                                - 4 -

would repay the balance outstanding on the loan in the event the

insured died.

     Southwestern Dealers Insurance Co. (SDI) was formed by a

group of automobile dealership owners whose dealerships issued

policies similar to those issued through Messrs. McCurley's and

Hall's dealerships.    In February of 1982, SDI was incorporated in

Grand Cayman under the laws of the Cayman Islands, British West

Indies.    Mr. McCurley became an SDI shareholder in 1982 and

served as chairman of SDI's board of directors from that year

forward.    Mr. Hall became an SDI shareholder in 1984.   Prior to

becoming shareholders, Messrs. McCurley and Hall reviewed letters

prepared by Peat, Marwick, Mitchell & Co., outlining issues

relating to the formation of SDI and the availability of

interest-free loans.    The letter cautioned that adverse tax

consequences would result if the loans were not bona fide loans.

     SDI reinsured credit insurance policies issued through

dealerships (i.e., the dealerships served as agents of the

insurance companies) owned by SDI shareholders.    As described

below, reinsurance profits from policies attributable to a

particular shareholder's dealership were then allocated to that

shareholder.    Seventy-five percent of the allocated profits was

readily accessible to the shareholder through interest-free

loans.

     SDI's articles of association (Articles) set forth the rules

governing the corporation.    They authorized the issuance of
                               - 5 -

ordinary shares, which carried one vote per share, and preferred

shares, which carried no voting rights.    During the relevant

years, SDI had between 16 and 24 shareholders and each held one

ordinary share and 340 preferred shares.

     SDI maintained a redemption account for each shareholder.

Pursuant to the Articles, the amount of a shareholder's

redemption account:   (1) Represented the price at which SDI would

redeem that shareholder's preferred shares, (2) formed a basis

for allocating dividends to that shareholder, and (3) served as a

point of reference for determining the maximum amount of funds

that SDI could advance that shareholder.

     Preferred shares were redeemable for a price based on a

formula.   The formula provided that preferred shares could be

redeemed for an amount equal to (1) the shareholder's capital

contributions and share of SDI's profits (e.g., profits

attributable to policies issued by the shareholder's dealerships)

and investment income, less (2) his share of SDI's losses and

dividends paid with respect to the shares.    Negative redemption

accounts reduced other redemption accounts pro rata.

     SDI did not pay dividends.   It did, however, advance

interest-free funds to its shareholders.    The Articles authorized

the board to approve an advance to a shareholder if such advance

and all previous advances for that shareholder did not exceed 75

percent of that shareholder's redemption account.    If a

shareholder's redemption account declined in value such that the
                               - 6 -

total advances to the shareholder exceeded 75 percent of his

redemption account, the board of directors would demand repayment

to the extent of the excess.   The board demanded repayment of two

of the more than 70 advances to shareholders.    In each case,

repayment was demanded because, after a decline in the value of

the shareholder's redemption account, advances to the shareholder

exceeded 75 percent of the account.

     All advances were recorded on SDI's certified financial

statements as loans receivable.   To obtain an advance, a

shareholder was required to execute an application.    The

applications generally stated the amount of the advance requested

and provided that:   (1) No interest would accrue; (2) the board

would demand repayment if the shareholder's total advances

exceeded 75 percent of that shareholder's redemption account; and

(3) the shareholder's redemption account could be used to satisfy

any outstanding advances.   These applications were routinely

approved by SDI's board of directors.   SDI denied only two

applications.   These applications were denied because the future

profitability of the respective applicant's redemption account

was questionable.

     SDI advanced funds to Messrs. McCurley and Hall.    Each time

Messrs. McCurley and Hall requested funds, they executed an

application and submitted it to SDI's board of directors.     The

board approved, by resolution, each advance.    Messrs. McCurley

and Hall each tendered noninterest-bearing demand notes in the
                                 - 7 -

amount of the funds received.    During the years in issue, SDI

advanced a total of $275,661 to Mr. McCurley and $138,596 to Mr.

Hall.    SDI did not demand repayment of, and Messrs. McCurley and

Hall did not repay, any of the advances.

       During the years in issue, the McCurleys and Halls filed

joint Federal income tax returns.    On those returns, they did not

report their advances from SDI as income.    For each of the years

in issue, certified public accountants prepared the McCurleys'

and Halls' tax returns.

       Respondent issued notices of deficiency to the McCurleys

relating to their 1988, 1989, 1990, 1991, and 1992 returns.

Respondent also issued a notice of deficiency to the Halls

relating to their 1989, 1990, and 1991 returns.    Respondent

determined that Messrs. McCurley and Hall had income equal to the

amounts SDI advanced to them.    In the alternative, respondent

determined that 75 percent of the annual increases in Messrs.

McCurley's and Hall's redemption accounts was taxable to them as

income constructively received.    For the McCurleys' 1992 tax

year, respondent determined a deficiency based solely on the

constructive receipt theory.    Respondent concedes that if we

conclude petitioners received income when advances were made to

them, there will be no deficiency in the McCurleys' 1992 income

tax.    Respondent also determined an addition to tax and accuracy-

related penalties.

                                OPINION
                                 - 8 -

I.   Constructive Dividends

      A distribution of cash or property from a foreign

corporation to a domestic shareholder with respect to the

corporation's stock generally is, to the extent of the

corporation's earnings and profits, taxable to the shareholder as

a dividend.   See secs. 301(c), 316(a); sec. 1.316-1(a)(1), Income

Tax Regs.   Petitioners do not dispute that SDI had earnings and

profits in excess of the amounts paid to Messrs. McCurley and

Hall.

      A dividend need not be formally declared, but may be

constructive.   Noble v. Commissioner, 368 F.2d 439, 442 (9th Cir.

1966), affg. T.C. Memo. 1965-84.    Whether a distribution from a

corporation to a shareholder constitutes a dividend or a loan

depends on whether the corporation has conferred a benefit on the

shareholder without the expectation of repayment.    See, e.g.,

Noble v. Commissioner, supra at 443; Chism's Estate v.

Commissioner, 322 F.2d 956, 959-960 (9th Cir. 1963), affg. Chism

Ice Cream Co. v. Commissioner, T.C. Memo. 1962-6.    A purported

loan from a corporation to a shareholder will not be

characterized as a loan unless, at the time the funds were

transferred, the transferee had an unconditional obligation to

repay the funds, and the transferor had an unconditional

intention to secure repayment.     Haag v. Commissioner, 88 T.C.

604, 615-616 (1987), affd. without published opinion 855 F.2d 855

(8th Cir. 1988).   This determination is to be made based on all
                               - 9 -

of the facts and circumstances of the case.    Chism's Estate v.

Commissioner, supra at 960.   Petitioners bear the burden of

proving that the advances were bona fide loans.    Welch v.

Helvering, 290 U.S. 111, 115 (1933).   After considering all of

the facts and circumstances, we conclude that the advances were

constructive dividends to Messrs. McCurley and Hall.

     Several factors support our conclusion.   First, SDI never

paid formal dividends to its shareholders.    Second, petitioners

did not establish that SDI demanded, or that Messrs. McCurley or

Hall volunteered, repayment of the advances.   See Georgiou v.

Commissioner, T.C. Memo. 1995-546 (stating that the failure to

repay a steadily increasing loan balance is indicative of

constructive dividends); Baird v. Commissioner, T.C. Memo. 1982-

220 (same).   Third, the advances did not bear interest.      Fourth,

the advances to Messrs. McCurley and Hall were expressly made

with reference to their redemption accounts (i.e., their share of

SDI's profits).   Fifth, the advances were not repayable at a

fixed maturity date, but rather were repayable on demand.      Sixth,

out of more than 70 advances made to shareholders, SDI demanded

repayment of only two.   Moreover, the repayments were demanded

solely because the respective shareholder's advances exceeded 75

percent of his redemption account.

     In essence, SDI was designed and intended to capture each

shareholder's insurance-related profits and to provide the
                                 - 10 -

shareholder with tax-free and interest-free access to profits

attributable to policies issued through the shareholder's

dealership.    Messrs. McCurley and Hall would not repay their

advances unless it was in their economic interests to do so.

Petitioners have not persuaded us that it would ever be in their

economic interests to repay these advances.     Mr. McCurley, Mr.

Hall, and SDI viewed the advances as permanent distributions with

the understanding that there was a remote possibility that SDI

would demand repayment.   Accordingly, we hold that the advances

to Messrs. McCurley and Hall were constructive dividends.

II.   Penalties and Addition to Tax

      A.   Section 6662 Penalties for Negligence

      Section 6662(a), applicable to the McCurleys' 1991 and 1992

tax years and the Halls' 1989, 1990, and 1991 tax years, provides

for an accuracy-related penalty equal to 20 percent of the

portion of any underpayment to which the section applies.     The

section applies to, among other items, the portion of an

underpayment attributable to negligence or disregard of rules or

regulations.    Sec. 6662(b)(1).   Negligence has been defined as

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).     It includes the

failure to make a reasonable attempt to comply with the Internal

Revenue Code.    Sec. 6662(c).   Section 6664(c) states that the

accuracy-related penalty for negligence does not apply to any
                                - 11 -

portion of an underpayment attributable to reasonable cause.

Reasonable reliance on the advice of a tax professional may

constitute reasonable cause.     Sec. 1.6664-4(b), Income Tax Regs.

     Petitioners contend that they exercised due care in

reporting the advances as loans.     Petitioners also contend that

they reasonably relied on professional advice and that, as a

result, their underpayments were attributable to reasonable

cause.     Messrs. McCurley and Hall did not unconditionally intend

to repay the advances, and they knew or reasonably should have

known that there was only a remote possibility that SDI would

demand repayment of their advances.      As a result, we reject

petitioners' contentions and hold that they are liable for the

accuracy-related penalties for negligence.      Because we have held

that the McCurleys did not understate their income in 1992,

however, they are not liable for the negligence penalty for that

year.

     B.     Section 6661 Addition to Tax for Substantial
            Understatement

        Section 6661(a), applicable to the McCurleys' 1988 tax year,

provides for an addition to tax equal to 25 percent of the amount

of an underpayment attributable to a substantial understatement.

See Pallottini v. Commissioner, 90 T.C. 498, 503 (1988).      The

term "understatement" means the excess of (1) the amount of tax

required to be shown on the return over (2) the amount of tax

shown on the return, reduced by any rebate.      Sec. 6661(b)(2)(A).
                               - 12 -

Section 6661(b)(2)(B) provides that the understatement determined

under section 6661(b)(2)(A) must be reduced by the portion of the

understatement for which the taxpayer had "substantial

authority".    A taxpayer has substantial authority where the

weight of the authorities supporting the taxpayer's position is

substantial in relation to the weight of authorities supporting

contrary positions.    Sec. 1.6661-3(b)(1), Income Tax Regs.

     The McCurleys contend that they have not understated their

income within the meaning of section 6661, because they had

substantial authority for characterizing the advances as loans.

They contend that four cases support treatment of the advances as

loans.   See Pierce v. Commissioner, 61 T.C. 424 (1974); White v.

Commissioner, 17 T.C. 1562 (1952); Wiese v. Commissioner, 35

B.T.A. 701 (1937), affd. 93 F.2d 921 (8th Cir. 1938); Miller v.

Commissioner, T.C. Memo. 1980-445.      None of these cases, however,

explicitly or implicitly provides that where a taxpayer does not

intend to repay an advance he is nevertheless justified in

reporting it as a loan.    As a result, we reject their contention.

     The McCurleys also contend that the understatement was due

to reasonable cause and that, as a result, respondent should have

waived the penalty.    See sec. 6661(c).    The standard of our

review is whether the Commissioner's failure to waive the penalty

was an abuse of discretion.    Mailman v. Commissioner, 91 T.C.

1079 (1988).    The McCurleys knew or should have known that the

advances were not bona fide loans.      Therefore, their
                             - 13 -

understatements were not due to reasonable cause.    As a result,

there was no abuse of discretion by respondent.

     We have considered all other arguments made by the parties

and found them to be either irrelevant or without merit.

     To reflect the foregoing,


                                        Decisions will be entered

                                   for respondent.
