                        T.C. Memo. 1999-193



                      UNITED STATES TAX COURT



         RICHARD C. AND HATTIE M. MARTIN, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent

        WILLIAM L. AND SYLVIA L. MARTIN, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent


     Docket Nos. 18241-97, 18247-97.            Filed June 15, 1999.



     William M. Weintraub and Brian J. Wright, for petitioners.

     Michael H. Salama and Ian Russell, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     JACOBS, Judge:   These cases were consolidated for purposes of

trial, briefing, and opinion.
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       Pursuant      to    separate   notices     of    deficiency,    respondent

determined     the        following     deficiencies      and     accuracy-related

penalties:

Richard C. and Hattie M. Martin, Docket No. 18241-97:

Year                       Deficiency                  Sec. 6662(a)

1992                       $103,871                     $20,774
1993                         55,302                      11,060
1994                         35,991                       7,198


William L. and Sylvia L. Martin, Docket No. 18247-97:

Year                       Deficiency                   Sec. 6662(a)

1992                        $62,427                      $12,485
1993                         21,793                        4,359
1994                         31,405                        6,281

       Following concessions by the parties, the primary remaining

issue to be resolved is whether Cola Performance Products, Inc. is

to be recognized as a distinct taxable entity during 1992, 1993,

and    1994,   the    consequence     being     the    disallowance    of   certain

business losses individually claimed by petitioners for each of

those years.1     Also at issue is whether petitioners are liable for

section 6662(a) accuracy-related penalties.




       1
          William L. Martin acknowledged that he was not involved
in the automotive crankshaft manufacturing business at issue, and
therefore he and his wife concede that they are not entitled to
the business losses they individually claimed. They request that
all business losses for the years in issue be attributed to
Richard C. and Hattie M. Martin.
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     All section references are to the Internal Revenue Code and

all Rule references are to the Tax Court Rules of Practice and

Procedure.

                             FINDINGS OF FACT

     Some of the facts have been stipulated, and the stipulation of

facts is incorporated in our findings by this reference.

     Petitioners Richard C. (Richard) and Hattie M. Martin, husband

and wife, and petitioners William L. (William) and Sylvia L.

Martin,   husband   and   wife,   resided      in   Rolling   Hills   Estates,

California, at the time they filed their respective petitions in

this Court contesting respondent's determinations.               Richard and

William are brothers.

     Richard is a principal shareholder of a corporation that is

one of the largest commercial drywall, framing, and plastering

contractors in the Los Angeles area.            For many years, he had an

interest in car racing.

Formation of Cola, Inc.

     In 1988, Richard and Raul Negrete (Raul) (formerly, the

general   manager   of    L.A.   Billet,   a   manufacturer     of    race   car

crankshafts) decided to form a corporation that would engage in the

business of manufacturing automotive crankshafts for race cars (the

business).   Both agreed to contribute $100,000 to the corporation.

     On June 22, 1988, Richard's attorney, Mark A. Treadwell, of

Mantalica & Treadwell, filed the necessary corporate documentation
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with   the   State    of    California.      Originally,      the   name   of    the

corporation was Motor Motion, Inc.             On July 11, 1988, the name of

the corporation was changed to Cola Performance Products, Inc.

(Cola, Inc.).    Cola is an acronym for Crankshafts of Los Angeles.

       The first organizational meeting for Cola, Inc. was held on

July 22, 1988.        The minutes for that meeting (prepared by Mr.

Treadwell) reveal: (1) Corporate bylaws were adopted; (2) Raul and

Richard were elected directors of the company; (3) Raul was elected

president, and Richard was elected secretary/treasurer and chief

financial officer; (4) 200 shares of stock were authorized to be

issued and sold (100 shares to Raul and 100 shares to Richard)                    at

a price of $25 per share; and (5) the company was authorized to

establish a bank account with Union Bank.

       Shortly after the company was incorporated, Richard learned

that Raul would be financially unable to contribute to the business

because of a dispute with his prior business partner.                        In the

latter part of 1988, Richard discussed this situation with his

accountant, Sam White (a partner in the accounting firm of Deloitte

&   Touche),   and    the   controller    of    his    drywall    company,    Sandy

Hemphill.      They    recommended    that     as     long   as   Raul   could   not

financially contribute to the business, the business should be

operated by Richard as a sole proprietorship.

       No corporate stock was ever issued.
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     At all times during the years in issue (1992, 1993, and 1994),

Cola, Inc. was a California corporation in good standing.     As of

the date of trial, it had never been dissolved.

Equipment

     In mid-1988, Richard purchased the equipment to operate the

business.   The equipment (crankshafts and grinding machines) was

purchased from L.A. Billet and others.   Richard paid for this and

other equipment, as well as furniture and fixtures, using funds

from his own bank accounts and credit lines.      These assets were

never contributed to Cola, Inc.

Lease Agreement

     On July 21, 1988, Cola, Inc. entered into an agreement to

lease a building located at 19122 S. Santa Fe Avenue, Rancho

Dominguez, California (S. Santa Fe Avenue), which became the situs

for its business operation.    The lease was for a period of 60

months, commencing August 1, 1988, and was in existence at all

relevant times.

Bank Account and Financial Affairs

     The bank account with Union Bank was utilized as the business'

operating account during the years in issue.   The checks used for

this account contained the imprint "Cola Performance Products,

Inc.". Checks drawn on Cola, Inc.'s bank account were used to pay:

(1) Vendors and suppliers of the business; (2) various business
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expenses (such as utilities and telephone); and (3) rental payments

for the S. Santa Fe Avenue building.

     Cola,   Inc.    issued   invoices   to   its    clients   (vendors   and

suppliers) with the imprint Cola, Inc. at the top of the invoices.

Moreover, Cola, Inc.'s vendors and suppliers issued invoices to

Cola, Inc. for goods and services the business purchased.

     Cola, Inc. maintained a company credit card, which was used to

purchase goods and services for the business during 1992.              Cola,

Inc. also maintained a general ledger, cash receipts journals, and

sales journals.

Employer Identification Number

     On   February    6,   1991,   Richard    applied    for   an   employer

identification number as an individual using the business trade

name "Cola Performance Products".          The Internal Revenue Service

assigned an identification number to him.           This number was used by

the business in filing returns and reports with State and Federal

tax authorities.

Lawsuits Filed Against Cola, Inc.

     In August 1993, Beta Maskin AB (Beta Maskin), a Swedish

corporation, filed a civil action in the U.S. District Court for

the Central District of California against Cola, Inc., as well as

Richard and Raul individually, for failure to pay the contract

price of crankshafts Beta Maskin sold to Cola, Inc.            In the answer

to this action, the defendants stated:
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            Defendant Cola Performance Products, Inc. is at
       this time, and was at all times relevant hereto, a fully
       capitalized California corporation in good standing. Any
       and all dealings between plaintiff and any of the
       defendants were dealings between plaintiff and Cola
       Performance Products, Inc. Defendants Dick Martin and
       Raul Negrete were acting in their official capacities as
       officers and directors of Cola Performance Products, Inc.
       at all times relevant hereto, as was known to plaintiff
       and its representatives. Therefore, defendants Martin
       and Negrete, and each of them, have no liability to
       plaintiff in this action.

       During Richard's May 17, 1994, deposition, relating to the

Beta Maskin lawsuit, he stated:         (1) He owned 100 shares of Cola,

Inc.    stock;   (2)   Cola,   Inc.    held   regular   shareholders'   and

directors' meetings; (3) Cola, Inc. owned property such as grinding

equipment, mills, lathes, and other equipment for manufacturing

race car crankshafts; (4) he lent money to Cola, Inc. on several

occasions (as recent as 2 weeks prior to his deposition); and (5)

the debt owed to Beta Maskin was only that of Cola, Inc.

       Further, during his deposition, Richard answered the question:

"What information do you have that leads you to believe that Mr.

Lindstrom [the owner of Beta Maskin] and Beta Maskin dealt with

Cola Performance Products as a corporation as opposed to you and

Mr. Negrete as individuals?" by stating: "Mr. Lindstrom dealt with

Cola Performance Products, period.            He didn't deal with us as

individuals under any conditions, never has. We don't operate that

way.    We operate as a corporation."
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     Raul also was deposed on May 17, 1994, and he corroborated the

statements Richard made in his deposition.

        On   July    1,   1994,   the   defendants       filed      a    memorandum      of

contentions     of    facts   and     law,     asserting     that       Cola,    Inc.    had

substantial         capital   assets,        stockholders,       a       lease     for    a

manufacturing plant, and had engaged in a continuous course of

business activity since 1988.

        In November 1994, the Beta Maskin lawsuit was settled. The

parties agreed that only Cola, Inc. was liable for the asserted

obligation to Beta Maskin.            Richard and Raul signed the settlement

agreement as officers of Cola, Inc.               A note payable was created on

Cola, Inc.'s general ledger reflecting Cola, Inc.'s obligation

under the settlement agreement.

        Cola, Inc. was sued by other businesses with which it had

contracted; i.e., Axis Engineering in 1992, and Sterling Air Cargo,

Inc. in 1994.        In satisfaction of the default judgment in the Axis

Engineering     lawsuit,      Cola,     Inc.    issued   a   check       drawn    on     the

corporate bank account with the imprint "Cola Performance Products,

Inc."

Income Tax Returns

     Petitioners timely filed Federal income tax returns for 1992,

1993, and 1994. They individually claimed losses on Schedules C of

their respective tax returns for those years with respect to the

automotive crankshaft business, as follows:                  Richard and his wife,
                                   - 9 -


Hattie, claimed Schedule C losses of $540,567, $173,480, and

$248,653 for 1992, 1993, and 1994, respectively; and William and

his wife, Sylvia, claimed Schedule C losses of $195,541, $66,991,

and $90,170 for 1992, 1993, and 1994, respectively.

     Cola, Inc. filed corporate income tax returns (Forms 1120) for

1992, 1993, and 1994, reporting no taxable income or expenses

(other than a franchise tax fee paid to the State of California).

     Respondent   disallowed      the   Schedule    C    losses   petitioners

claimed on their respective returns on the grounds: (1) The losses

belonged to Cola, Inc., and not petitioners as individuals; and (2)

petitioners failed to demonstrate that the losses were actually

incurred.

                                  OPINION

Issue 1.    Characterization of Cola, Inc.

     The    fundamental   issue    involved    is       whether   Cola,   Inc.

constituted a separate corporate taxable entity during 1992, 1993,

and 1994.   Respondent contends that it did, and accordingly, Cola,

Inc.'s losses were improperly deducted on petitioners' individual

returns.    On the other hand, petitioners maintain that shortly

after Cola, Inc.'s formation, Richard learned that Raul would be

unable to contribute capital to the corporation as anticipated and

consequently, Richard was forced to abandon the business' corporate

form and operated it as a sole proprietorship.
                                    - 10 -


       Generally, a corporation organized for the purpose of carrying

on a business activity constitutes a separate taxable entity.                  See

Moline Properties, Inc. v. Commissioner, 319 U.S. 436 (1943).                    A

corporation will not be disregarded for Federal tax purposes if it

(1)    served    an   intended   business   function,    or    (2)   engaged    in

business.       See id. at 438-439.     However, if the corporate form is

a sham or unreal, it will be disregarded.          See        Higgins v. Smith,

308 U.S. 473, 477-478 (1940).

       Once the taxpayer has elected to conduct his business affairs

in corporate form, the taxpayer must accept any tax disadvantages

of that form.         See id. at 477.    A taxpayer is not free to "turn

around and disclaim the business form he created in order to

realize a loss as his individual loss."          Sangers Home for Chronic

Patients, Inc. v. Commissioner, 72 T.C. 105, 116 (1979); see also

Barker v. Commissioner, T.C. Memo. 1993-280.

       Whether a corporation exists or not is a matter of State law;

however, whether the corporate entity (if found to exist) should be

disregarded for Federal taxation purposes is a matter of Federal

law.     See Stoody v. Commissioner, 66 T.C. 710, 716-717 (1976).

Here, it is clear that Cola, Inc. was formed on June 22, 1988, as

a distinct corporate entity under California law and it continued

to be a valid, legally existing corporate body during the years at

issue.    And, for the reasons set forth below, we believe Cola,
                                         - 11 -


Inc.'s corporate status for Federal tax purposes should not be

disregarded.

     Cola, Inc. was not a sham.              It served an intended business

purpose.      Indeed, in this regard, through Cola, Inc.'s corporate

form,    Richard        and    Raul   insulated    themselves      from      individual

liability.          See, e.g., Strong v. Commissioner, 66 T.C. 12, 25

(1976), affd. without published opinion 553 F.2d 94 (2d Cir. 1977);

Bolger v. Commissioner, 59 T.C. 760 (1973). Most notably, this was

done when Beta Maskin filed a lawsuit against Cola, Inc., and

Richard and Raul.         Tellingly, in defending themselves, Richard and

Raul asserted that Cola, Inc. was "a fully capitalized California

corporation        in   good    standing",   and    that    they     acted    in   their

official capacities as officers and directors of Cola, Inc. in all

dealings with Beta Maskin.

        In addition to serving an intended business function, Cola,

Inc. engaged in business activities.               It maintained a bank account

from which receipts and expenditures flowed.                   It leased property

which was the situs of the automotive crankshaft manufacturing

business.      It maintained books and records.             It issued invoices to

clients.      It maintained a credit card.            And it held itself out to

the public as a distinct corporate entity.

        We   are   convinced      that   Cola,     Inc.    engaged    in     sufficient

business activities so as to render it a separate taxable entity.

In this regard, whether or not a corporation is deemed to engage in
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a business activity does not depend upon the quantum of business

activity but simply whether the entity engaged in some business

activity. See Dooley v. Commissioner, T.C. Memo. 1984-548 (citing

Britt v. United States, 431 F.2d 227 (5th Cir. 1970)); see also

Hospital Corp. of Am. v. Commissioner, 81 T.C. 520, 579-580 (1983);

Reed v. Commissioner, T.C. Memo. 1997-533.

     Petitioners point to Blue Flame Gas Co. v. Commissioner, 54

T.C. 584 (1970), as factually similar to the case herein.                        We

disagree.          At    the    time    the      taxpayers   filed   articles    of

incorporation in Blue Flame, they operated as a partnership.                     No

property was contributed to the corporation, no business was

conducted, and the corporation was subsequently abandoned.                       We

therein concluded that the losses were produced by the partnership.

See id. at 599.         The facts herein are clearly distinguishable from

those in Blue Flame.           Moreover, the taxpayer in Blue Flame "did not

seek the protective shield of corporate existence against business

creditors", id. at 600, in sharp contrast to what happened here.

     In     sum,    the    losses      resulting      from   the   manufacture   of

crankshafts for race cars during the years in issue are those of

Cola,     Inc.,    and    not     those     of     petitioners.      Consequently,

petitioners are not entitled to deduct those losses on their

respective individual Federal income tax returns.
                                    - 13 -


Issue 2.    Section 6662(a) Accuracy-Related Penalties

     The other issue for decision is whether petitioners are liable

for the section 6662(a) accuracy-related penalties for the years in

issue.

     Pursuant to section 6664(c)(1), a section 6662 penalty does

not apply to any portion of an underpayment if reasonable cause

existed and the taxpayers acted in good faith. Pursuant to section

1.6664-4(b)(1), Income Tax Regs., all facts and circumstances must

be examined in order to determine whether a taxpayer acted with

reasonable cause and in good faith.

     Petitioners assert that they had reasonable cause to deduct

Cola, Inc.'s losses on their individual Federal income tax returns

for the years in issue.        They contend that they relied in good

faith upon Sam White who prepared their returns for the years in

issue.    Mr.   White   did   not   testify   due   to   the   fact   he   was

incarcerated at the time of trial.

     In order to establish good faith reliance on the advice of an

adviser, the taxpayer must prove:       (1) He gave the return preparer

complete and accurate information, (2) an incorrect return was a

result of the preparer's mistakes, and (3) the taxpayer believed in

good faith that he was relying on a competent return preparer's

advice.    See Metra Chem Corp. v. Commissioner, 88 T.C. 654, 662

(1987).
                                - 14 -


     As to Richard and his wife, we are satisfied that they

reasonably relied upon the advice of Mr. White in claiming the

business losses on their individual tax returns for the years at

issue. After Richard learned that Raul would be financially unable

to contribute to the business, he met with Mr. White and Ms.

Hemphill.    Ms. Hemphill corroborated that such a meeting occurred.

She testified that, at this meeting, it was decided that "Cola

Performance would operate as a sole proprietorship and was not

going to operate as a corporation."      We found Ms. Hemphill to be a

credible witness.     Accordingly, we do not sustain respondent's

accuracy-related penalties determination as to Richard C. and

Hattie M. Martin for any of the years in issue.

     However, as to William and his wife, we are not satisfied that

they reasonably relied upon the advice of Mr. White in claiming the

business losses on their individual tax returns for the years at

issue.    William testified that "Sam White came to me and said that

he * * * [believed] * * * that [I could] participate in some

losses.     And I said, if that's what you think I can do, be my

guest."     William and his wife, Sylvia, claimed Cola, Inc.'s losses

even though they were aware that they had neither an ownership

interest in, nor an involvement with, the business.      By doing so,

they did not act in good faith; we believe a reasonably prudent

person under the same circumstances would not have claimed the

losses.     Accordingly, we sustain respondent's accuracy-related
                             - 15 -


penalties determination as to William L. and Sylvia L. Martin for

1992, 1993, and 1994.

     To reflect the foregoing and concessions of the parties,



                                             Decisions will be

                                      entered under Rule 155.
