                       T.C. Memo. 1997-519



                     UNITED STATES TAX COURT



             GUSTAFSON'S DAIRY, INC., Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 24670-93.                Filed November 17, 1997.



     John S. Ball and Beverly H. Furtick, for petitioner.

     Michael A. Pesavento and Benjamin A. DeLuna, for

respondent.

             MEMORANDUM FINDINGS OF FACT AND OPINION
     COLVIN, Judge:1 Respondent determined the following

deficiencies in and additions to petitioner's Federal income

taxes:



     1
       This case was previously assigned to Judge Edna G. Parker.
In Gustafson's Dairy, Inc. v. Commissioner, T.C. Memo. 1995-11,
she decided whether to shift the burden of proof to respondent
under sec. 534(a)(2). Trial was held before Judge Parker. She
died on Nov. 12, 1996, before deciding the case. The Chief Judge
reassigned the case to this division of the Court. We granted
petitioner's motion for a new trial, and a new trial was held.
                                 -2-

                                     Additions to tax
  FYE                          Sec.           Sec.                  Sec.
Mar. 312    Deficiency     6653(a)(1)(A) 6653(a)(1)(B)             6653(a)

 1987       $372,401          $18,620          *                     --
 1988        674,386           33,719          *                     --
 1989        246,286            --                                 $12,314

* 50 percent of the interest due on the deficiency.

     After concessions, we must decide:

     (1) Whether petitioner is liable for the accumulated

earnings tax imposed by section 5313 for fiscal years 1987, 1988,

and 1989.    We hold that it is not.

     (2) Whether petitioner is liable for additions to tax for

negligence.4   We hold that it is to the extent discussed below.

                          Table of Contents

                         I. Findings of Fact                                   Page

A.   Petitioner and the Gustafson Family . . .     .   .   .   .   .   .   .   .   3
     1.   Petitioner . . . . . . . . . . . . .     .   .   .   .   .   .   .   .   3
     2.   The Gustafson Family . . . . . . . .     .   .   .   .   .   .   .   .   4
     3.   Officers and Stock Ownership . . . .     .   .   .   .   .   .   .   .   4
     4.   Stock Purchase Agreement . . . . . .     .   .   .   .   .   .   .   .   5
     5.   Repayment of Debt Owed to Shareholder    .   .   .   .   .   .   .   .   6
B.   Dairy Operations . . . . . . . . . . . . .    .   .   .   .   .   .   .   .   7
     1.   Milk Production and Processing . . .     .   .   .   .   .   .   .   .   7

     2
       Petitioner's 1987, 1988, and 1989 fiscal years ended on
March 31.
     3
       Unless otherwise indicated, section references are to the
Internal Revenue Code. Rule references are to the Tax Court
Rules of Practice and Procedure.
     4
       For fiscal year 1988, respondent determined that
petitioner was liable for the environmental tax under sec. 59A in
the amount of $1,177. Petitioner offered no evidence or argument
relating to this issue. Respondent contends that it is merely
computational. We leave resolution of the amount petitioner owes
to the Rule 155 computations.
                                -3-

     2.   The Dairy Association . . . . . . . . . . .   .   .   .   . . 8
     3.   Petitioner's Sales to Winn-Dixie and Others   .   .   .   . . 9
     4.   Competition . . . . . . . . . . . . . . . .   .   .   .   . 11
     5.   Diseases . . . . . . . . . . . . . . . . .    .   .   .   . 11
     6.   Petitioner's Environmental System . . . . .   .   .   .   . 13
C.   Petitioner's Finances . . . . . . . . . . . . .    .   .   .   . 14
     1.   Petitioner's Capital Expenditures Program .   .   .   .   . 14
     2.   The Super Trust . . . . . . . . . . . . . .   .   .   .   . 19
     3.   Petitioner's Expansion Plans . . . . . . .    .   .   .   . 21
     4.   Insurance . . . . . . . . . . . . . . . . .   .   .   .   . 22
     5.   Petitioner's Financial Condition . . . . .    .   .   .   . 25
     6.   Petitioner's Bardahl Calculations . . . . .   .   .   .   . 28
     7.   Petitioner's Business Practices . . . . . .   .   .   .   . 29

                                II. Opinion

A.   Accumulated Earnings Tax . . . . . . . . . . . . . . .         .   30
     1.   Basic Rules . . . . . . . . . . . . . . . . . . .         .   30
     2.   Burden of Proof . . . . . . . . . . . . . . . . .         .   31
B.   Whether Petitioner Was Formed or Availed of To Avoid
     Shareholder Level Taxation . . . . . . . . . . . . . .         .   32
     1.   Whether Petitioner Intended To Avoid Shareholder
          Level Taxes . . . . . . . . . . . . . . . . . . .         .   32
     2.   Factors Identified in Treasury Regulations . . .          .   35
     3.   Conclusion . . . . . . . . . . . . . . . . . . .          .   37
C.   Reasonable Accumulation for Business Needs . . . . . .         .   38
     1.   Background . . . . . . . . . . . . . . . . . . .          .   38
     2.   Herd Expansion and Pollution Control . . . . . .          .   40
     3.   Capital Improvements . . . . . . . . . . . . . .          .   43
     4.   Debt Retirement . . . . . . . . . . . . . . . . .         .   46
     5.   Self-Insurance for Replacement of Herd . . . . .          .   48
D.   Conclusion . . . . . . . . . . . . . . . . . . . . . .         .   50
E.   Environmental Tax . . . . . . . . . . . . . . . . . .          .   51
F.   Negligence . . . . . . . . . . . . . . . . . . . . . .         .   51

                       I.   FINDINGS OF FACT

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

A.   Petitioner and the Gustafson Family

     1.   Petitioner

     Petitioner is a Florida corporation the principal place of

business of which was in Green Cove Springs, Florida, when it

filed its petition in this case.   Petitioner produces raw milk
                                 -4-

and processes it into dairy products.    Petitioner reports its

income using the accrual method of accounting.    Petitioner's

fiscal year ends on March 31.

     2.   The Gustafson Family

     Agnes and Frank Gustafson established a dairy in Green Cove

Springs, Florida, in 1908.    They moved it to the present location

in the 1920's, and incorporated petitioner in 1954.

     Agnes and Frank Gustafson had six children.    Three of their

children died before the years in issue:    F.N. (Noel) Gustafson,

Helen Gustafson Amara, and Julia Gustafson Bagley.    G.J. (Pete)

Gustafson died in 1995.    Two of their children were alive at the

time of trial:    E.S. Gustafson (age 80) and Ellen Gustafson

Townsend (age 82).    E.S. (Sherwood) Gustafson, Jr., is the son of

E.S. Gustafson.

     3.   Officers and Stock Ownership

     Pete and Noel Gustafson worked full time for petitioner.

Noel Gustafson was president and manager of petitioner until he

died in 1984.    E.S. Gustafson became petitioner's president and

chief executive officer in 1986 and remained in that position

through the years in issue.    Sherwood Gustafson was the executive

vice president and general manager in the years in issue.    E.S.

Gustafson and Sherwood Gustafson have worked for petitioner all

of their adult lives.    E.S. Gustafson ran petitioner and was

involved in virtually all aspects of petitioner's business in the

years in issue.
                                -5-

     From August 29, 1984, to March 31, 1988, the members of

petitioner's board of directors were E.S. Gustafson, Pete

Gustafson, and Sherwood Gustafson.    E.S. Gustafson and Sherwood

Gustafson were petitioner's only board members in fiscal year

1989.

     Sherwood Gustafson's son, E.S. (Eddie) Gustafson III, works

on the farm under the direction of the farm manager.   He is a

member of the fourth generation of the Gustafson family working

for petitioner.

     Petitioner's stock is wholly owned by descendants or by

spouses of descendants of Agnes and Frank Gustafson, or by trusts

of which members of the Gustafson family are the beneficiaries.

During the years at issue, there were no discordant shareholders.

     4.   Stock Purchase Agreement

     Gustafson family shareholders have kept control of

petitioner by restricting the sale or disposition of petitioner's

stock to outsiders.   Beginning in 1984, petitioner held an option

granting it the right to redeem its preferred stock for $1,000

per share if a shareholder transferred his or her stock,

including a transfer when a shareholder died.   Under the

agreement, petitioner had 30 years to pay for the redeemed stock.

Petitioner's policy has been to redeem a shareholder's stock

under the stock purchase agreement when he or she dies to provide
                                  -6-

money for estate taxes and administration under section 3035 and

to keep control of the company in the Gustafson family.

     In 1984 and 1985, petitioner paid $1,702,000 to redeem stock

held by Noel Gustafson's estate.    Petitioner also redeemed Julia

Bagley's stock when she died in 1979.    During the years in issue,

petitioner expected that it would need about $1,700,000 to redeem

the stock of Pete Gustafson.   However, petitioner did not redeem

his stock when he died in 1995 because his estate did not need

money to pay estate taxes.   Petitioner plans to redeem Ellen

Gustafson Townsend's stock when she dies.    The redemption price

for her 350 shares will be $350,000.

     5.   Repayment of Debt Owed to Shareholder

     During its 1988 fiscal year, petitioner repaid $2,586,750 in

debentures it owed to Pete Gustafson's trust and related interest

of $735,339 ($3,322,089 total).    Petitioner's tax attorney

advised petitioner to retire the debentures.    Most of the

debentures would have become payable in 20146 or when Pete

Gustafson died, whichever occurred first.    Pete Gustafson was 84

years old in 1988 and not in good health.


     5
       Under sec. 303, a distribution of property to a
shareholder to redeem the shareholder's stock to pay death taxes
is treated as a distribution in full payment in exchange for the
redeemed stock.
     6
       One of the debentures would have matured in 2015, one in
2016, and one in 2017.
                                  -7-

B.   Dairy Operations

     1.     Milk Production and Processing

     Petitioner operates a dairy farm that produces raw milk.

During the years in issue, petitioner's dairy herd was one of the

largest in the United States at one location.     Petitioner also

operates a dairy processing plant that produces finished dairy

products and a milk distribution business.     Petitioner's dairy

farm and milk processing plant border the southern city limits of

Green Cove Springs.     Petitioner's operations have gradually

shifted over the years, including the years at issue, from milk

producing to milk processing.     Petitioner also owns and manages a

beef herd, grows timber, and raises crops.

     Petitioner has an open herd rather than a closed herd.      In

an open herd, replacement cows are bought from third parties.       In

a closed herd, replacements are raised from calves on the farm.

Petitioner had in inventory and bought the following number of

cows from fiscal year 1983 to fiscal year 1993:

                              Dairy                Dairy
          Fiscal year   cattle inventory     cattle purchased
             1983             7,585           not available
             1984             6,770           not available
             1985             5,920               1,458
             1986             6,100               2,863
             1987             6,004               2,707
                                  -8-

           1988             5,849              2,473
           1989             5,725              2,419
           1990             5,262              2,634
           1991             5,432              2,574
           1992             5,285              2,226
           1993             4,691              2,195


     Petitioner reduced the size of its dairy herd from 1983 to

1985 so it could participate in the Milk Diversion Program, which

was administered by the U.S. Department of Agriculture.   Dairy

and Tobacco Adjustment Act of 1983, Pub. L. 98-180, sec. 102(a)

(sec. 201(d)(3)(A) of the Agricultural Act of 1949), 97 Stat.

1128, 1129-1130.   The purpose of the program was to reduce the

production of raw milk in the United States.   Id.   Petitioner

received $2,052,061.30 ($398,343.50 in fiscal year 1984 and

$1,653,717.80 in fiscal year 1985) from the program.   The program

ended on March 31, 1985.

     2.   The Dairy Association

     During the years in issue, petitioner's dairy produced about

one-third of the raw milk it needed in its processing plant.

During the years in issue, petitioner sold all of the milk it

produced to a dairy cooperative, the Florida Dairy Farmers

Association (Dairy Association), and bought all of the milk it
                               -9-

processed and sold from the Dairy Association.   Petitioner joined

the Dairy Association so it would have enough milk to process.

     Petitioner bought more than $19,000,000 of raw milk to

process in each of the years in issue.   Petitioner's payments to

the Dairy Association were 55 to 59 percent of petitioner's cost

of goods sold for the years at issue.

     3.   Petitioner's Sales to Winn-Dixie and Others

     Petitioner sells milk products under its own label.

Petitioner distributes its products to about 2500 retail outlets.

Petitioner maintains a fleet of more than 200 trucks to

distribute its products.

     About 80 percent of petitioner's sales of processed milk in

the years in issue were to six customers:   Winn-Dixie Stores,

Inc. (Winn-Dixie), Publix, Lil' Champ, Pic-N-Sav, Walgreens, and

Miller Enterprises.

     Petitioner's biggest customer was Winn-Dixie.   Winn-Dixie

has purchased milk products from petitioner for almost 50 years.

Almost half of petitioner's sales during the years in issue were

to Winn-Dixie.

     Petitioner processes, packages, and distributes some of the

"Superbrand" products, the private label milk for Winn-Dixie.
                              -10-

     Petitioner provided Superbrand milk for Winn-Dixie's stores

in Winn-Dixie's Jacksonville District.    Petitioner also processes

and sells milk to Winn-Dixie under the Gustafson's Dairy label.

     Petitioner must pass inspections conducted by Winn-Dixie to

retain its Winn-Dixie Superbrand account.   Petitioner has

complied with modifications requested by Winn-Dixie during its

periodic inspections of petitioner's plant.

     Petitioner has never had a written contract with Winn-Dixie.

Winn-Dixie could end its relationship with petitioner without

notice, but had not done so by the years in issue.

     About 10-20 years before trial, Winn-Dixie began to produce

Superbrand milk in its own production facilities.    Winn-Dixie now

processes and packages Superbrand milk for all of its stores in

Florida except those in the Jacksonville District.   Petitioner is

the sole remaining outside supplier of Winn-Dixie's Superbrand

milk.

     Winn-Dixie was founded by four brothers named Davis and is

headquartered in Jacksonville, Florida.   The Davis family owned a

controlling interest in Winn-Dixie during the years at issue.

The children of Agnes and Frank Gustafson had a close social

relationship with the Davis brothers over the years, including

the years at issue.
                                 -11-

     4.   Competition

     Petitioner's major competitors in the years in issue were

Dean Foods, Borden's (the largest milk processor in the country

during the 1980's), Sealtest, and Flav-O-Rich.    These are large,

publicly held corporations.

     The number of milk processors in northern Florida has

steadily declined in the last 20 to 25 years.    Many of the

processors which were similar in size to petitioner had gone out

of business or sold out to larger companies before or during the

years in issue.

     5.   Diseases

     Petitioner frequently reviewed the risk of exposure of its

cattle to diseases and contaminated feed with its veterinarian.

Although the threat to petitioner's cattle from individual

diseases has changed over the years, the overall risk posed by

disease has increased as its cattle have become more concentrated

in smaller areas.    Some diseases have been cured, but the risk

from others such as bovine virus diarrhea, bovine leukemia virus,

and fescue foot has increased.    The fact that petitioner has an

open herd increases the herd's risk of disease because diseased

cows may be brought into the herd.
                               -12-

     Petitioner's dairy herd is at risk of suffering from

diseases such as brucellosis, tuberculosis, and mastitis.    The

herd is also at risk of being exposed to contaminants such as

aflatoxin (contamination of feed).    Petitioner has never lost

cattle because of tuberculosis or aflatoxins.    Cows brought to

Florida are tested for brucellosis and tuberculosis.    Brucellosis

is a contagious disease.   Cows with brucellosis must be

slaughtered.   About 1,300 of petitioner's 9,000 cows died of

brucellosis from March 5, 1974, to April 21, 1976, and about 200

of petitioner's other cows were afflicted by brucellosis.

     Petitioner received a slaughter price for each cow it culled

from its herd during the brucellosis outbreak in the mid-1970's.

During the years in issue, the slaughter price was about $400 per

cow, and the replacement cost was $950 to $1,050.    Petitioner

could also receive indemnities of $25 from Florida and an amount

unspecified in the record from the Federal government for each

cow slaughtered due to brucellosis.

     Petitioner's herd was vaccinated for brucellosis from 1975

to 1993, and was quarantined by the State of Florida from the

mid-1970's to October 1988.   Although petitioner's herd was

brucellosis-free in 1988, about 120 of its cows tested positive

for brucellosis from 1985 to 1989.
                               -13-

     Petitioner would receive no indemnity if it destroyed

animals because they had tuberculosis or certain other diseases.

     6.   Petitioner's Environmental System

     In October 1988, a dike forming a part of petitioner's

animal waste control system failed, causing effluent to be

discharged over a 10-acre area.

     Petitioner knew by the end of March 1989 that it had

significant environmental problems but did not fully appreciate

how severe those problems were.   The chief engineer of the Soil

Conservation Service (SCS) of the U.S. Department of Agriculture

evaluated petitioner's property and made recommendations for

designing petitioner's environmental system.   He told Sherwood

Gustafson during the design process from October 1988 to June

1990 that petitioner would have to reduce the size of the herd

because petitioner's land could not accommodate an animal waste

control system for all of its existing herd.

     Petitioner applied for a permit to build a new animal waste

control system (the environmental system) in 1990.   The SCS

designed petitioner's new environmental system.   The Florida

Department of Environmental Regulation (DER) approved the plans

in June 1990.   The new system required petitioner to keep its

herd in a small high-intensity area (HIA) and to build a 90-acre
                                 -14-

holding lagoon.    The environmental system could accommodate 5,500

cows.     SCS designed the environmental system to accommodate as

many cows as possible.

     Petitioner applied for a construction permit around December

21, 1990.     The Florida DER issued the permit on April 18, 1991.

Due to delays in construction, the permit was extended to

November 4, 1994, and then to April 18, 1996.

     Petitioner spent $21,616 for pollution control in fiscal

year 1989, and $139,868 in fiscal year 1990.     Petitioner spent

$5,210,970 on the environmental system from April 1, 1988, to

March 31, 1995.

C.   Petitioner's Finances

     1.     Petitioner's Capital Expenditures Program

     In March 1985, petitioner's board of directors told its

controller to prepare detailed 5-year capital expenditure

projections for its annual meetings.    Petitioner's board of

directors made this request after petitioner had received

$2,052,061.30 from the Milk Diversion Program.    John Fisher,

petitioner's controller for the years in issue, prepared the

capital expenditures program (CEP) report with the help of E.S.

Gustafson, Sherwood Gustafson, and petitioner's attorney, James

Sheehan.
                               -15-

     Petitioner's controller's March 1986 CEP report stated that:

(a) Petitioner must expand its herd and milking facilities to

meet the demand of the milk cooperative because Government

programs will reduce the number of cows in Florida; and (b) due

to the exorbitant increase in liability insurance costs,

petitioner will reduce insurance from $10,000,000 to $5,000,000

and self-insure for the remaining $5,000,000.

     Petitioner's board analyzed its business needs in detail in

each of the years in issue and concluded that it needed much more

money than it had.   The CEP listed three categories of

expenditures.   Category one was capital expenditures, self-

insurance reserves, and petitioner's working capital needs for

the next fiscal year.   Category two listed probable needs for the

2 years after the next fiscal year.   Category three projected

probable needs for the 2 years after that.   Petitioner intended

to implement the plans recorded in all three categories, but

category one was more definite than category two and category two

was more definite than category three.

     The CEP did not count amounts transferred to the Super

Trust, discussed below at paragraph I-C-2, as funds available to

meet petitioner's projected expenses.
                                  -16-

     Petitioner projected in the CEP for fiscal years 1986-89

that it would spend or accumulate the following amounts (in

thousands of dollars):

                           1986            1987     1988        1989

Category one:
 Equip./constr.           $1,960        $560       $1,155       $400
 Pollution                     60        --            50        500
 Land                       --           --            50      1,500
 Working capital           3,000       3,000        3,200      3,600
 Self-ins. (liab.)         5,000       5,000        5,000      5,000
 Self-ins. (herd)           --         3,300        3,900      3,900
     Total               $10,020     $11,860      $13,355    $14,900

Category two:
 Equip./constr.           $1,565         $1,650      $950     $3,500
 Pollution                  --               50       500        500
 Land1                       200            200     1,500      2,000
 Herd expansion            1,425          1,425     1,575      1,575
 Self-ins. (herd)2          --             --         975        975
     Total                $3,190         $3,325    $5,500     $8,550

Category three:
 Equip./constr.3          $1,115         $1,115    $1,8354    $1,195
 Land                       --             --       2,000       --
 Herd expansion            1,425          1,425     1,575      1,575
 Self-ins. (herd)2          --              825     3,9005       975
     Total                $2,540         $3,365    $9,310     $3,745

Grand total              $15,750     $18,550      $28,165    $27,195

     1
       In the projections for category two for 1988 and category
one for 1989, the $1,500,000 amount for land assumed petitioner
would buy 3,000 acres at $500 per acre. In the 1989 category two
projection, the $2,000,000 amount for land assumed petitioner
would buy 800 acres at $2,500 per acre.
     2
       These amounts were based on the assumption that petitioner
would expand its herd by 1,500 cows.
                                -17-
     3
       These amounts were to provide new facilities needed for a
larger herd.
     4
         This amount included $500,000 for pollution control.
     5
       Petitioner concedes that the amount for self-insurance for
the expanded part of the herd should have been $975,000, not
$3,900,000.

     Petitioner's projected and actual expenses compared as

follows:
                        -18-

                   CATEGORY ONE

                     Projected     Actual expenses in
     Year            expenses        following year
3/31/87
 Equip./constr.      $560,000          $865,043
 Pollution              0                 0
 Land                   0                 0

3/31/88
 Equip./constr.     1,155,000         1,157,335
 Pollution             50,000            21,616
 Land                  50,000             0

3/31/89
 Equip./constr.       400,000           847,859
 Pollution            500,000           139,868
 Land               1,500,000             0
     Total         $4,215,000        $3,031,721


                   CATEGORY TWO

                                  Actual expenses
                   Projected       in second and
     Year          expenses         third years
3/31/87
 Equip./constr.    $1,650,000        $2,005,194
 Pollution             50,000           161,484
 Land                 200,000             0
 Herd expansion     1,425,000             0

3/31/88
 Equip./constr.       950,000         1,758,299
 Pollution            500,000         1,241,695
 Land               1,500,000         2,249,625
 Herd expansion     1,575,000             0

3/31/89
 Equip./constr.     3,500,000        1,672,171
 Pollution            500,000        1,487,947
 Land               2,000,000        2,249,625
 Herd expansion     1,575,000            0
     Total        $15,425,000      $12,826,040
                               -19-

     2.    The Super Trust

           a.   Formation and Purpose

     On March 31, 1988, E.S. Gustafson formed Gustafson's Dairy

Farm Super Trust (the Super Trust) to induce petitioner's

shareholders to make some of their personal assets available to

petitioner to help meet petitioner's long-term financial needs

(i.e., 5 to 20 years in the future) and to hold petitioner's

voting stock.   E.S. Gustafson was the grantor and individual

trustee.   The Florida National Bank (later First Union National

Bank of Florida) was the corporate trustee.   Petitioner's board

authorized the creation of the Super Trust.   Tax considerations

were not a factor when petitioner established the Super Trust.

     The Super Trust agreement charged the trustee of the Super

Trust with determining the highest and best use of petitioner's

8,000 acres and other land to be acquired by petitioner, deciding

the size of the dairy herd and whether to split the dairy herd

into smaller herds, and making decisions concerning the

distribution of petitioner's products.   The Super Trust did not

manage petitioner and was not concerned with meeting petitioner's

short-term (5 years or less) needs.
                                  -20-

           b.    Funding of the Super Trust

     Petitioner and members of the Gustafson family contributed

liquid assets and stock in petitioner to the Super Trust.      These

assets were held in separate funds for each contributor.

     Petitioner transferred $3,677,911 to the Super Trust in

fiscal year 1988 and $1,250,000 in fiscal year 1989.      Petitioner

accounted for these transfers on its books by reducing cash and

retained earnings by the amounts of the transfers.      Petitioner

reported these transfers as nondeductible contributions from

retained earnings on its Federal income tax returns.      Petitioner

received the net income from its fund but was not entitled to

have its principal returned until the Super Trust was terminated.

E.S. Gustafson had sole discretion to invade the principal of

petitioner's fund in the Super Trust and to direct how to use it.

          c.     Trust Income

     The Super Trust filed Forms 1041, U.S. Fiduciary Income Tax

Return, for 1988 and 1989.      It reported no taxable income for

those years.    Most of its income was from tax-exempt municipal

bonds.   Petitioner failed to report $35,285.08 of taxable income

and $152,637.74 of tax-exempt municipal bond interest earned by
                                -21-

the Super Trust in fiscal year 1989.    Petitioner concedes that it

should have reported this income for 1989.    Petitioner's failure

to report the income did not result in an income tax deficiency

because petitioner's income was more than offset by fuel excise

tax credits in 1989.

     3.     Petitioner's Expansion Plans

     In 1988, petitioner decided to develop a comprehensive land

use plan for the 8,000 acres adjoining its dairy.   Petitioner

believed that the area around the dairy would be developed and

that petitioner would move.

     Petitioner projected in category two of its CEP for fiscal

year 1988 and in category one of its CEP for fiscal year 1989

that it needed to spend $1,500,000 on land.   Petitioner

negotiated to buy property from the Roberts family (the Roberts

property) in 1989.   However, petitioner did not buy the Roberts

property.

     During the years in issue, petitioner's board learned that

Union Camp Corp. planned to develop 56,000 acres of land that it

owned adjacent to and south of petitioner's property.   The Union
                                   -22-

Camp project was named "The Villages of Seminole Forest".       Union

Camp announced the project on July 26, 1990.

     Around December 31, 1990, petitioner bought 1,799.7 acres of

land from Union Camp (the Union Camp property) for $2,249,625 in

cash, of which $1,200,000 came from petitioner's fund in the

Super Trust.     The Union Camp property adjoined petitioner's land

and increased petitioner's land holdings to about 9,500 acres.

     In 1993, Union Camp announced that it would not develop The

Villages of Seminole Forest, and petitioner dropped its plans to

develop its property contiguous to the Union Camp property.

     4.   Insurance

          a.      Herd Insurance

     Petitioner carried no commercial insurance on its herd in

the years in issue.    Most dairy farmers do not commercially

insure their herds because it is too expensive.

     Petitioner estimated how much it needed for a reserve by

subtracting the expected salvage price from the replacement cost

for its herd of 6,000 cows.    Petitioner assumed that its

replacement cost would be $950 per cow in 1987, and $1,050 in

1988 and 1989.    Petitioner increased the self-insurance reserve
                                 -23-

for fiscal years 1988 and 1989 because the cost of cows

increased.   Petitioner estimated that it would receive a

slaughter price of $400 for each cow.    Thus, petitioner's board

had a reserve of $3,300,000 in fiscal year 1987 (6,000 cows x

$550), and $3,900,000 in fiscal years 1988 and 1989 (6,000 cows x

$650) to cover losses to the dairy herd in the event of disease

or other disaster.

          b.      Liability Insurance

     Petitioner bought commercial liability insurance and funded

a reserve for self-insurance for risks above $5,000,000 in the

years in issue.

     During the years in issue, petitioner was covered by

Insurance Company of North America (INA) primary liability

insurance policies.7    Petitioner had the following commercial

liability insurance policies:




     7
       Some of petitioner's insurance policies provided per
occurrence coverage and others provided aggregate coverage. A
per occurrence policy pays up to the amount of the policy for
each covered loss. An aggregate policy pays no more than the
amount of the policy during the policy period regardless of the
number of claims.
                                 -24-

          Category          Policy amounts    Annual premium
    Business auto          $500,000 per      $130,000-140,000
                           occurrence
    Comprehensive          1,000,000 per       45,000-75,000
    general liability      occurrence
                                                     1
    Products liability     1,000,000 per
                           occurrence and
                           aggregate


1
  The premium for comprehensive general liability insurance
includes the premium for products liability insurance.

     Petitioner had insurance on its farm buildings and farm

personal property.

     Petitioner also had umbrella policies8 in the years in

issue.   From 1983 to 1985, petitioner carried $10,000,000 of

umbrella coverage.   In July 1985, U.S. Fire Insurance Co. (U.S.

Fire) decided not to offer umbrella policies with coverage

exceeding $5,000,000.    U.S. Fire's decision remained in effect

for 12 to 18 months.     In July 1986, U.S. Fire notified petitioner

that it would not renew petitioner's $5,000,000 umbrella policy

at the end of the policy period on October 1, 1986.      As a result,


     8
       An umbrella insurance policy is a supplemental liability
policy that protects against losses above the amount covered by
other liability insurance policies.
                                  -25-

petitioner reduced its umbrella coverage from $10,000,000 to

$5,000,000 and self-insured for risks above $5,000,000.

Petitioner had an umbrella policy providing per occurrence and

aggregate coverage of $5,000,000.        The annual premium for this

policy was $57,000 to $67,000.         Benefits under this policy were

payable only if petitioner had exhausted the primary policies.

Petitioner had the following umbrella insurance coverage from

1983 to 1989:

                                                            Annualized
  Policy period        Insurer               Limits           premium

 11/11/83-1/1/85   Western Employers    $10 mil. per         $6,517
                                        occur. and
                                        aggregate
  1/1/85-10/1/85      U.S. Fire         $10 mil. per         12,467
                                        occur.
 10/1/85-10/1/86      U.S. Fire         $5 mil. per          23,500
                                        occur.
  1/1/86-1/1/879         INA            $5 mil. aggregate    57,096
  1/1/87-1/1/88          INA            $5 mil. aggregate    66,707
  1/1/88-1/1/89          INA            $5 mil. aggregate    57,130
  1/1/89-1/1/90          INA            $5 mil. aggregate    46,245



     5.    Petitioner's Financial Condition

     Petitioner paid no dividends in fiscal year 1982, but it

paid dividends annually from 1983 through the years in issue.

Petitioner paid almost $900,000 in dividends to its stockholders

from March 31, 1983, to March 31, 1989, an average of about 10


     9
       During the first 6 months of the 1987 fiscal year (from
Mar. 31 to Oct. 1, 1986), petitioner carried $10,000,000 of
commercial umbrella liability insurance.
                                        -26-

percent of its net after-tax income.           During the years at issue,

petitioner's net income after taxes was $1,095,848 for fiscal

year 1987, $1,877,983 for fiscal year 1988, and $1,058,277 for

fiscal year 1989.       Petitioner paid dividends of $100,000,

averaging about 7.44 percent of net after-tax income, in each of

those years.

     Petitioner's book income, taxes paid, book net income after

taxes, dividends paid, and percentage of net income paid as

dividends for fiscal years 1982 to 1989 were as follows:



                        INCOME, TAXES PAID, AND DIVIDENDS
                                                                    Percentage of
   Tax                                     Book net                  net income
  year     Book net                      income after   Dividends      paid as
 ending     income      Federal taxes        taxes        paid        dividends
3/31/82   $1,483,898       $586,418        $897,480         0           0.0
3/31/83   2,244,000        725,508        1,518,492     $299,421       19.7%
3/31/84    642,513          85,440         557,073      100,057         18.0
3/31/85   3,002,591       1,245,977       1,756,614      99,966         5.7
3/31/86   1,738,731        693,338        1,045,393     100,000         9.6
3/31/87   2,029,349        933,501        1,095,848     100,000         9.1
3/31/88   2,980,721       1,102,738       1,877,983     100,000         5.3
3/31/89   1,511,400        453,123        1,058,277     100,000         9.4
  Total   $15,633,203     $5,826,043      $9,807,160    $899,444        9.2%




     Petitioner's annual sales increased from $26,254,806 in

fiscal year 1982 to $42,493,252 in fiscal year 1987, $43,627,256

in fiscal year 1988, and $42,978,226 in fiscal year 1989.
                                    -27-

     Petitioner paid salaries to its officers from fiscal year

1982 to fiscal year 1989 as follows:

          Fiscal                                         Sherwood
           year    E.S. Gustafson    G.J. Gustafson     Gustafson
           1982       $275,000             $140,000      $60,000
           1983       275,000              140,000       60,000
           1984       275,000              140,000       60,000
           1985       400,000              140,000       135,000
          1986        450,000              145,000       265,000
          1987        450,000              140,000       270,000
          1988        450,000              140,000       305,000
          1989        400,000              140,000       325,000


     Petitioner's net available current assets (i.e., current

assets plus liquid assets held in petitioner's fund in the Super

Trust10 less current liabilities) were as follows:

                                         Current        Net liquid
   Fiscal year      Current assets     liabilities         assets
          1982        $7,358,893           $2,380,061   $4,978,832
          1983        7,665,571            3,081,937     4,583,634
          1984        6,892,987            2,129,431     4,763,556
          1985        11,272,122           4,139,044     7,133,078
          1986        11,089,919           2,857,557     8,232,362
          1987        12,049,090           2,759,589     9,289,501
          1988        12,916,884           2,775,775    10,141,109



     10
       Petitioner concedes that amounts it held in the Super
Trust are liquid assets available to it for purposes of this
case.
                                              -28-

             1989            13,956,580              3,120,759         10,835,821



        Petitioner's current asset to current liability ratios were

4.36 for fiscal year 1987, 4.65 for fiscal year 1988, and 4.47

for fiscal year 1989.

        Petitioner's retained earnings increased from $8,810,568 to

$16,796,904 from March 31, 1982, to March 31, 1989, as follows:

                           RETAINED EARNINGS AND SUPER TRUST FUNDS

               Book                                      (1)          (2)
             beginning                                   Book        Super          (3)
             retained                                   ending       Trust       Total of
 Year        earnings     Additions   Deductions       retained      funds        (1) and
                                                       earnings                     (2)

 1982        $7,913,088   $897,480        0           $8,810,568       0           N/A

 1983        8,810,568    1,736,844    $299,421       10,247,991       0           N/A

 1984        10,247,991    557,073     100,057        10,705,007       0           N/A

 1985        10,705,007   1,756,614     99,966        12,361,655       0           N/A

 1986        12,361,655   1,045,393    200,056        13,206,992       0           N/A

 1987        13,206,992   1,095,848    756,733        13,546,107       0           N/A

 1988        13,546,107   2,596,370   3,777,914       12,364,563   $3,677,911   $16,042,47

                                                                                    4

 1989        12,364,563    887,555    1,609,867       11,642,251   5,154,653    16,796,904




        6.       Petitioner's Bardahl Calculations

        Petitioner estimated its working capital needs in the

capital reports at each of the year-end meetings.                          Petitioner did

not use the Bardahl11 formula to calculate its working capital



        11
       Bardahl Manufacturing Corp. v. Commissioner, T.C. Memo.
1965-200.
                               -29-

needs for fiscal year 1987.   The minutes for petitioner's March

31, 1988, board meeting included a Bardahl calculation for the

first time.   The minutes of the March 31, 1989, meeting also

included a Bardahl calculation.    Petitioner based its Bardahl

calculations on its prior year's expenses because petitioner had

not closed its books by the time of the year-end meetings and

operating expenses for the current year were not available.

     Based on its operating expenses for the year ending March

31, 1987, petitioner concluded that it needed $3,200,000 for

working capital for fiscal year 1988.   For fiscal year 1989,

petitioner concluded that it needed $3,600,000 for working

capital.

     7.    Petitioner's Business Practices

     E.S. Gustafson regularly gave about $30,000 of his own money

as Christmas gifts to petitioner's employees.   Neither he nor

petitioner deducted these gifts.   E.S. Gustafson made Christmas

gifts to the employees for about 15 years, including the years in

issue.

     Petitioner did not lend money to or own stock in its

suppliers during the years at issue.    Petitioner's officers and

directors do not serve as officers or directors of any of its

suppliers.

     Petitioner did not lend money to its shareholders or invest

in unrelated businesses or ventures during the years in issue.

Petitioner does not own any airplanes, yachts, condominiums, or
                                 -30-

similar facilities, and does not insure the lives of its

shareholders.

                           II.    OPINION

A.   Accumulated Earnings Tax

     1.    Basic Rules

     A corporation is subject to the accumulated earnings tax if

it is formed or availed of to avoid income taxation of its

shareholders by accumulating earnings and profits.    Sec. 532(a).

The most important factor in deciding if the accumulated earnings

tax applies is whether a corporation accumulates earnings and

profits beyond the reasonable needs of the business.     United

States v. Donruss Co., 393 U.S. 297, 307 (1969); Technalysis

Corp. v. Commissioner, 101 T.C. 397, 403 (1993).     A corporation

that accumulates earnings and profits beyond its reasonable

business needs is presumed to do so to avoid income tax of its

shareholders.   Sec. 533(a).   A taxpayer can rebut the presumption

with a preponderance of evidence to the contrary.    Sec. 533(a).

The accumulated earnings tax does not apply if a corporation has

unreasonably accumulated earnings but lacks the proscribed

purpose.   Technalysis Corp. v. Commissioner, supra at 403; Pelton

Steel Casting Co. v. Commissioner, 28 T.C. 153, 173 (1957), affd.

251 F.2d 278 (7th Cir. 1958).

     The accumulated earnings tax is a penalty and is strictly

construed.   Ivan Allen Co. v. United States, 422 U.S. 617, 626

(1975); Pelton Steel Casting Co. v. Commissioner, supra at 172-
                                -31-

173.    Whether a corporation was formed or availed of to avoid tax

or has permitted its earnings and profits to accumulate beyond

its reasonable needs are questions of fact.    United States v.

Donruss Co., supra at 307; Helvering v. National Grocery Co., 304

U.S. 282 (1938); Bremerton Sun Publ'g Co. v. Commissioner, 44

T.C. 566, 582 (1965).

       2.   Burden of Proof

       Before respondent issued the notice of deficiency in this

case, respondent notified petitioner that respondent proposed to

issue a notice of deficiency for fiscal years 1987, 1988, and

1989 including a determination that petitioner is liable for

accumulated earnings tax under section 531.    Petitioner submitted

a timely statement under section 534(c) stating the grounds on

which it relied to establish that it had not accumulated earnings

beyond the reasonable needs of its business.    In this statement,

petitioner alleged that it had the following grounds for

accumulating earnings:    (a) Working capital needs, (b) self-

insurance (general and product liability), (c) replacement of its

herd, (d) replenish/increase herd and animal waste control

system, (e) capital improvements, (f) dependence on Winn-Dixie

and fears of competition, and (g) herd relocation and land

development.    In its petition, petitioner asserted that it had

two additional grounds for accumulation:    stock redemption and

retirement of debt.
                                -32-

     In Gustafson's Dairy, Inc. v. Commissioner, T.C. Memo. 1995-

11, we held that the burden of proof is on respondent for ground

(d) for 1987 and 1988, and for the first $550,000 for 1989, and

for ground (e) to the extent of petitioner's purchase of the

Union Camp property for $2,249,625.    The burden of proof is on

petitioner as to whether it permitted its earnings and profits to

accumulate beyond the reasonable needs of its business for all

other grounds, and whether it was formed or availed of to avoid

shareholder level taxation.    Gustafson's Dairy, Inc. v.

Commissioner, supra.

B.   Whether Petitioner Was Formed or Availed of To Avoid
     Shareholder Level Taxation

     1.   Whether Petitioner Intended To Avoid Shareholder Level
          Taxes

     E.S. Gustafson and Sherwood Gustafson thought that

petitioner would have difficulty surviving in competition with

large corporate milk producers.   They knew that many dairy

farmers in northern Florida had gone out of business before or

during the years at issue.    They were concerned that petitioner

might lose the Winn-Dixie account.     They wanted petitioner to be

able to redeem the stock of Pete Gustafson when he died.    They

wanted petitioner to be free of debt.

     By the time of the years at issue, Sherwood Gustafson had

worked for petitioner for 25-27 years, his entire adult life.      He

felt responsible for the continued survival of the business.    His

lifelong commitment to running the dairy gave him a strong sense
                               -33-

of obligation that petitioner survive in a highly competitive

business.   Avoidance of tax at the shareholder level played no

part in the financial management of petitioner by E.S. Gustafson

and Sherwood Gustafson.

     Respondent contends that petitioner was formed or availed of

to avoid shareholder level taxation.   Respondent argues that

petitioner's detailed plans are an attempt to avoid the

accumulated earnings tax.   Respondent argues that the fact that

E.S. Gustafson and Sherwood Gustafson knew about the accumulated

earnings tax during the years in issue, that petitioner attached

Bardahl computations to its minute sheets, and that petitioner

used language in its CEP and minutes like that used in the

accumulated earnings tax statutes shows that petitioner acted

merely to avoid the accumulated earnings tax.   We disagree.

Petitioner properly had and contemporaneously recorded its

specific and definite plans.

     Respondent argues that we should disregard petitioner's

grounds for accumulating funds that were not listed in the CEP12

and argues that petitioner's failure to include certain grounds

in the CEP shows that those grounds were not bona fide.   We

disagree.   Petitioner reasonably recognized the potential harm to

its business if it lost the Winn-Dixie account; the fact that it

     12
       Petitioner did not list the following grounds for
accumulation in its CEP: (a) Dependence on Winn-
Dixie/competition, (b) herd relocation and land development, (c)
stock redemption, and (d) debt retirement.
                                -34-

could not quantify the amount it needed for this potential

problem does not make it any less of a concern.

     Respondent contends that petitioner formed the Super Trust

solely to conceal income and avoid the accumulated earnings tax.

Respondent argues that petitioner incorrectly accounted for its

contributions to the Super Trust and that petitioner should have

reported income from the Super Trust during the years in issue.

     We disagree that petitioner created the Super Trust to avoid

the accumulated earnings tax.   Also, the Super Trust properly

filed Forms 1041 for 1988 and 1989, and petitioner reported its

transfers to the Super Trust on Schedule M-2 of its 1988 and 1989

returns.   The Super Trust served many legitimate purposes; for

example, it helped to induce the shareholders to pledge their

funds for the long-term benefit of the company.   Respondent

admitted in the answer to petitioner's amended petition13 that

the Super Trust funds were pledged for the reasonable business

needs of petitioner.

     Respondent contends that, in estimating its reasonable

business needs, petitioner's CEP erroneously failed to consider

petitioner's projected future revenues.   We disagree.   Respondent

cites Dixie, Inc. v. Commissioner, 277 F.2d 526, 528 (2d Cir.


     13
       Petitioner amended paragraph 5(s) of its petition as
follows:

     5(s). The funds in the Super Trust are held for the
     reasonable business needs of the Petitioner.
                                -35-

1960), affg. 31 T.C. 415 (1958), for the proposition that the

taxpayer must assume that it will continue to be profitable in

analyzing its business needs at the end of each year, or to count

future revenues as a source for financing those needs.

Respondent's reliance on Dixie, Inc. v. Commissioner, supra, is

misplaced.   The U.S. Court of Appeals for the Second Circuit

noted in passing that the taxpayer had not considered future

earnings as one of several factors showing that the taxpayer did

not formulate a specific and definite plan for which accumulating

earnings would have been reasonable.   Id.

     2.    Factors Identified in Treasury Regulations

     Treasury regulations list the following as examples of

factors to consider in determining whether a corporation was

formed or availed of to avoid income tax of its shareholders:

(a) Dealings between the corporation and its shareholders for the

personal benefit of the shareholders, such as personal loans; (b)

corporate investment of undistributed assets in unrelated

businesses or investments; and (c) the corporation's dividend

history.   Sec. 1.533-1(a)(2), Income Tax Regs.   We next consider

how those factors apply here.
                               -36-

          a.    Dealings Between Petitioner and Its Shareholders

     Petitioner did not lend money to, or spend funds to

personally benefit, its shareholders.

          b.    Investment in Unrelated Businesses

     Petitioner did not invest in unrelated businesses.

          c.    Petitioner's Dividend History

     Petitioner paid dividends which averaged about 10 percent of

its after-tax income from 1983 through the years in issue.

Dividends averaged about 7.5 percent for the 3 years in issue.

     Petitioner paid substantial salaries to its officers from

1983 to 1989.   This generally shows that the taxpayer did not

intend to avoid shareholder level taxes.     Technalysis Corp. v.

Commissioner, 101 T.C. at 410-411; Bremerton Sun Publ'g Co. v.

Commissioner, 44 T.C. at 588; John P. Scripps Newspapers v.

Commissioner, 44 T.C. 453, 473 (1965).

     Respondent points out that petitioner's controller and

Sherwood Gustafson did not know how E.S. Gustafson decided the

amount of dividends to pay, and argues that petitioner's dividend

history was poor in view of its increasing liquidity.    Respondent

contends that petitioner's dividends were not sufficient.    We

disagree; level dividends may be sufficient.     Bremerton Sun

Publ'g Co. v. Commissioner, supra; John P. Scripps Newspapers v.

Commissioner, supra at 473 (the taxpayer paid the same amount of

dividends for 9 years).   Respondent relies on Doug-Long, Inc. v.

Commissioner, 72 T.C. 158 (1979).     In that case, the taxpayer
                                -37-

paid minimal dividends before the first year in issue.   The

taxpayer's president and sole shareholder reduced his salary so

that the total amount he received from the taxpayer (dividends

plus salary) was virtually unchanged for 4 years.    Id. at 182.

Unlike Doug-Long, Inc., petitioner paid a reasonable amount of

dividends from 1983 to 1989, the salaries paid to petitioner's

officers steadily increased before the years in issue, and

petitioner did not reduce dividends to keep payments to its

shareholders level.

     Although petitioner could have paid larger dividends, it

reasonably chose to use those funds to expand its business.    Its

business did grow as shown by the substantial increase in its

annual sales from 1982 to 1989.   We think petitioner prudently

decided to pay reasonable dividends and salaries to its officer-

shareholders, and retained the rest of its earnings to expand the

business.    See John P. Scripps Newspapers v. Commissioner, supra

at 473 (taxpayer acted prudently in distributing a substantial

part of its earnings and retaining the remainder to use to expand

its operations).

     3.     Conclusion

     We conclude that petitioner was not formed or availed of to

avoid income tax on its shareholders.
                                 -38-

C.   Reasonable Accumulation for Business Needs

     1.      Background

     A business may accumulate earnings to meet its reasonably

anticipated needs.     Sec. 537(a); sec. 1.537-1(a)(1), Income Tax

Regs.     The corporation must have specific, definite, and feasible

plans to use the accumulation.    Sec. 1.537-1(b)(1), Income Tax

Regs.14    We consider the judgment of corporate management in

deciding if its accumulation of earnings was reasonable.     Raymond

I. Smith, Inc. v. Commissioner, 292 F.2d 470, 475-476 (9th Cir.

1961), affg. 33 T.C. 141 (1959); Technalysis Corp. v.

Commissioner, supra at 411.

     A corporation's reasonably anticipated needs are considered

based on the facts at the end of the taxable year.    Sec. 1.537-

1(b)(2), Income Tax Regs.15    Treasury regulations state that


     14
       Sec. 1.537-2(b), Income Tax Regs., lists several
nonexclusive examples of reasonable grounds for accumulating
earnings and profits: (1) To provide for bona fide expansion of
business or replacement of plant; (2) To acquire a business
enterprise through purchasing stock or assets; (3) To provide for
the retirement of bona fide indebtedness created in connection
with the trade or business * * *; (4) To provide necessary
working capital for the business, such as, for the procurement of
inventories; (5) To provide for investments or loans to suppliers
or customers if necessary in order to maintain the business of
the corporation; or (6) To provide for the payment of reasonably
anticipated product liability losses * * *.
     15
          Sec. 1.537-1(b)(2), Income Tax Regs., provides:
                                                      (continued...)
                                  -39-

subsequent events may not be considered to show that an

accumulation was unreasonable if the taxpayer reasonably

anticipated the need at the end of the taxable year, but may be

considered to determine whether the corporation consummated or

intended to consummate the plan for which the earnings and

profits were accumulated.   Id.    At the start of the trial, the

parties agreed that the standard stated in section 1.537-1(b)(2),

Income Tax Regs., applies in deciding what is relevant to whether

petitioner's accumulation was reasonable.

     We next consider whether petitioner had reasonable grounds

for its accumulation of earnings in the years in issue.



     15
      (...continued)
          (2) Consideration shall be given to reasonably
     anticipated needs as they exist on the basis of the
     facts at the close of the taxable year. Thus,
     subsequent events shall not be used for the purpose of
     showing that the retention of earnings or profits was
     unreasonable at the close of the taxable year if all
     the elements of reasonable anticipation are present at
     the close of such taxable year. However, subsequent
     events may be considered to determine whether the
     taxpayer actually intended to consummate or has
     actually consummated the plans for which the earnings
     and profits were accumulated. In this connection,
     projected expansion or investment plans shall be
     reviewed in the light of the facts during each year and
     as they exist as of the close of the taxable year. If
     a corporation has justified an accumulation for future
     needs by plans never consummated, the amount of such an
     accumulation shall be taken into account in determining
     the reasonableness of subsequent accumulations.
                                  -40-

     2.   Herd Expansion and Pollution Control

     Respondent has the burden of proof on these issues for 1987

and 1988, and to the extent of $550,000 for pollution control for

1989; petitioner has the burden of proof for amounts above

$550,000 for 1989.    Gustafson's Dairy, Inc. v. Commissioner, T.C.

Memo. 1995-11.

          a.     Herd Expansion

     Petitioner claims that it needed to accumulate $1,425,000 in

fiscal year 1987, $1,575,000 in fiscal year 1988, and $1,575,000

in fiscal year 1989 to replenish and enlarge the dairy herd.

Respondent argues that petitioner had no definite plans to

enlarge the herd because the CEP contained no projections in

category one for herd expansion for the years in issue.

Respondent points out that petitioner's herd decreased from 7,585

cows in 1983 to 5,725 cows in 1989.      Respondent argues that the

fact that petitioner's herd decreased before and during the years

in issue and the fact that petitioner never implemented its plan

to enlarge its herd shows that petitioner's accumulation for this

purpose was not reasonable.   Respondent contends that petitioner,

and not the SCS, chose the 5,500 cow limit.     We disagree.

     Petitioner listed in the CEP for fiscal years 1986 through

1989 that it projected to accumulate amounts for herd expansion
                               -41-

in category two and category three, using an assumed market price

of $950 in 1987 and $1,050 in 1988 and 1989, and an assumed

expansion of 1,500 head.   Petitioner planned to enlarge its herd

but was forced to postpone its plans because the dike failed in

October 1988.

     The SCS designed the environmental system to accommodate the

largest permissible herd on petitioner's land.   The maximum

number of cows that petitioner could have on its existing land

was 5,500.   Thus, the limit on herd size in response to

petitioner's animal waste problems does not show that petitioner

did not want to increase its herd.    Petitioner's accumulation for

herd expansion in 1989 was reasonable because petitioner did not

know at the end of fiscal year 1989 that it would have to limit

the size of its herd.

     Petitioner had definite and specific plans to expand its

herd in 1987, 1988, and 1989, and reasonably accumulated

$1,425,000 in 1987 and $1,575,000 in 1988 and 1989 for this

purpose.

           b.   Pollution Control

     Petitioner contends that it reasonably accumulated $50,000

in fiscal year 1987, $550,000 in fiscal year 1988, and $1,000,000

in fiscal year 1989 for pollution control and improvements to its
                               -42-

environmental system.   Respondent concedes that petitioner

reasonably accumulated $21,616 in 1988 and $139,868 in 1989 for

pollution control (the lesser of the category one projected

expenses in 1988 and 1989 and the actual expenses in the year

immediately after the projections).   Respondent argues that

petitioner did not anticipate spending large amounts for

pollution control in 1989 or accumulate large amounts for this

purpose until 1992.

     The dike ruptured in October 1988, about 6 months before the

end of fiscal year 1989.   Petitioner began to accumulate earnings

and profits for pollution control in 1987 because it knew it had

problems with its animal waste control system.   Petitioner

projected that it needed to accumulate $50,000 in category two to

improve its pollution control in fiscal year 1987, $550,000 in

fiscal year 1988 ($50,000 in category one and $500,000 in

category two), and $1,000,000 in fiscal year 1989 ($500,000 in

category one and $500,000 in category two).   Petitioner had

projected before the dike broke that it would spend these

amounts.   After the dike broke, petitioner projected that it

would spend much more to fix its system to comply with DER; but

petitioner still underestimated the cost.   Petitioner projected

that it would spend more than it actually spent for category one,
                                 -43-

and less than it actually spent for category two.    In category

one, projected expenses exceeded actual expenses by $28,384 for

1988, and by $360,132 for 1989.    In category two, actual expenses

exceeded projected expenses by $101,484 for 1987, by $741,695 for

1988, and by $987,947 for 1989.

     We conclude that petitioner reasonably accumulated $50,000

for fiscal year 1987, $550,000 for fiscal year 1988, and

$1,000,000 for fiscal year 1989 for pollution control.

     3.   Capital Improvements

     Petitioner has the burden of proof on this issue.

Gustafson's Dairy, Inc. v. Commissioner, supra.

          a.     Equipment and Construction

     Petitioner accumulated $2,210,000 in fiscal year 1987,

$2,105,000 in fiscal year 1988, and $3,900,000 in fiscal year

1989 to buy equipment and vehicles and to make other capital

improvements.    Respondent concedes that petitioner reasonably

accumulated $560,000 for fiscal year 1987, $1,155,000 for fiscal

year 1988, and $400,000 for fiscal year 1989 for those purposes.

     Respondent disputes petitioner's claim that it needed to

accumulate funds to build more facilities to accommodate its

expanded herd.    Respondent points out that petitioner had 7,585

cows in 1983 and contends that petitioner had no need to build
                                 -44-

additional facilities if petitioner increased its herd to 7,500

cows.    We disagree.   The existing facilities (including a milking

parlor that could accommodate 10,000 cows) needed to be

modernized or replaced, and petitioner planned to expand its herd

to 9,000 cows.

     Respondent argues that most of the capital assets petitioner

bought during the years in issue were items that petitioner

bought each year, such as trucks, loaders, and refrigerators, and

were not assets bought as part of a capital expansion program.

Respondent argues that petitioner incorrectly counted this need

for funds both in its working capital calculations and in the

capital improvements category.    We need not decide whether

petitioner included this need for funds both in the capital

improvements category and in the working capital category because

we have not separately considered petitioner's working capital

needs.

     Petitioner's category one and two expenses projected for

equipment and construction were generally less than its actual

expenses for those purposes during those periods.    Actual

expenses in category one exceeded projected expenses by $305,043

for 1987, $2,335 for 1988, and $447,859 for 1989.    In category

two, actual expenses exceeded projected expenses by $355,194 for
                               -45-

1987 and $308,299 for 1988.   Projected expenses exceeded actual

expenses by $1,827,829 for 1989.   This confirms that petitioner

intended to spend the amounts it accumulated for equipment and

construction within the projected time periods.     See sec. 1.537-

1(b)(2), Income Tax Regs.   We hold that petitioner reasonably

accumulated $2,210,000 in fiscal year 1987, $2,105,000 in fiscal

year 1988, and $3,900,000 in fiscal year 1989 for equipment and

construction.

           b.   Land Development

     Petitioner contends that it needed to accumulate $2,000,000

during the years in issue to buy land.

     Respondent argues that petitioner had no plans to move its

operations to a less populated area and to develop its land into

a planned community during the years in issue, and that it was

not reasonable for petitioner to accumulate funds to develop

land.   Respondent argues that because the dairy is a pre-existing

use, Clay County will never force it to relocate.    We need not

consider this point because petitioner did not accumulate funds

to move its operations.

     Respondent argues that petitioner bought the Union Camp

property in December 1990, after respondent began a tax audit of

petitioner in February 1990, to avoid liability for the
                                -46-

accumulated earnings tax.    Respondent contends that petitioner's

failure to buy land from March 1986 to December 1990 shows that

petitioner was not serious about buying land.    We disagree.   The

1988 CEP projects expenses of $1,500,000 for land.    The CEP for

1989 projected expenses of $2,000,000 for land.    Petitioner paid

about $2,250,000 for the Union Camp property in fiscal year 1991.

The fact that petitioner bought the Union Camp property in

December 1990 does not show that petitioner was not previously

interested in buying land.   Sherwood Gustafson learned in 1987 or

1988 that Union Camp might sell some of its land adjoining

petitioner's land.   Sherwood Gustafson credibly testified that

petitioner would have bought the Roberts property if it had not

bought the Union Camp property.   Petitioner had specific,

definite, and feasible plans in fiscal year 1989 to use the

$2,000,000 to buy the Union Camp property.    We conclude that it

was reasonable for petitioner to accumulate $1,500,000 in fiscal

year 1988 and $2,000,000 in fiscal year 1989 to buy land.

     4.   Debt Retirement

     Petitioner has the burden of proof on this issue.

Gustafson's Dairy, Inc. v. Commissioner, T.C. Memo. 1995-11.

     Petitioner accumulated $3,300,000 in fiscal year 1987 to

retire debentures held by Pete Gustafson.    Respondent points out
                               -47-

that petitioner's debentures owed to Pete Gustafson did not

mature until the earlier of 2014 or when Pete Gustafson died.

Respondent argues that petitioner failed to show that it had a

definite purpose or plan to accumulate funds to retire debt

during the years at issue.

     We disagree.   Petitioner retired the debt held by Pete

Gustafson during fiscal year 1988, paying a total of $3,322,089.

Petitioner was obligated to repay the debt when he died.     Pete

Gustafson was 83 years old and in poor health in 1987.

Petitioner reasonably believed that it would have had to retire

the debentures long before 2014.   Petitioner redeemed the

debentures because it wanted to be debt-free.   Petitioner paid

more than $700,000 in accrued interest on the debentures during

fiscal year 1988.   Petitioner's tax attorney advised it to redeem

the debt because the interest on it was no longer deductible.

Redemption of debt is a valid justification for an accumulation.

Sec. 1.537-2(b)(3), Income Tax Regs.   We do not think the fact

that petitioner did not earmark these amounts in the CEP shows

that it did not reasonably accumulate amounts for that purpose.

     We find that petitioner reasonably accumulated $3,300,000 in

1987 to retire the debt held by Pete Gustafson.
                                 -48-

     5.      Self-Insurance for Replacement of Herd

     Petitioner has the burden of proof on this issue.

Gustafson's Dairy, Inc. v. Commissioner, supra.

     Petitioner contends that it accumulated $3,300,000 in fiscal

year 1987, $3,900,000 in fiscal year 1988, and $3,900,000 in

fiscal year 1989 to self-insure against loss of the dairy herd

due to diseases or other natural disasters.    This reserve was

based on an assumed herd size of 6,000 cows and a replacement

cost (net of the estimated slaughter price it would receive) of

$550 per cow in fiscal year 1987 and $650 per cow in fiscal years

1988 and 1989.

     Petitioner did not have commercial insurance for the risk of

loss of the dairy herd.    Few Florida dairies insure their herds

because herd insurance is expensive, not because there is no risk

of loss.   The fact that most dairies do not buy insurance

suggests that it was reasonable for petitioner to not buy

insurance.    See sec. 1.537-1(a), Income Tax Regs. (prudent

businessperson standard).

     Respondent argues that the risks to the herd were too remote

to justify maintaining self-insurance.    Respondent points out

that, except for the brucellosis outbreak in the 1970's,

petitioner's herd has not had significant losses.     Respondent

points out that hoof-and-mouth disease was eradicated in the

United States in the 1920's, that none of petitioner's cows have

had tuberculosis, that petitioner has lost no cattle from natural

disasters, and that petitioner's barns built in 1982 can
                                 -49-

withstand 100-mph winds.    Respondent also points out that

petitioner's expert, Richard Moscicki, testified that there was a

low probability that petitioner would lose its entire herd due to

disease or toxic contamination.    Finally, respondent contends

that the fact that petitioner waited more than 10 years after the

brucellosis outbreak to create the self-insurance reserve shows

that petitioner's purpose was to avoid the accumulated earnings

tax.

       We disagree that petitioner exaggerated the threat of

disease or other possible loss to its herd.      Petitioner lost

about 1,300 cows during the brucellosis outbreak in the 1970's.

About 120 of its cows tested positive for brucellosis from 1985

to 1989, and its cows were quarantined during the years in issue.

Petitioner's risks increased in the 1980's as more of its cattle

were concentrated in smaller areas.

       Loss history is relevant if it provides information about

the likelihood of the harm.    Cf. sec. 1.537-1(f)(2), Income Tax

Regs. (referring to product liability loss reserves).      However, a

taxpayer is not precluded from insuring against a potential loss

just because the taxpayer has not previously experienced that

particular loss.    EMI Corp. v. Commissioner, T.C. Memo. 1985-386.

       Respondent contends that petitioner improperly failed to

consider that an uninsured loss of cattle could provide tax

reductions, or that it may have legal recourse against the

supplier of contaminated feed.    We disagree.   An income tax
                                    -50-

deduction would not necessarily provide funds when needed to buy

new cattle, and would provide no benefit if petitioner had no

income.    If petitioner lost cattle due to contaminated feed, it

could take years to recover against the supplier.          We conclude

that petitioner's accumulation of funds to self-insure the herd

was reasonable.

D.   Conclusion

     Petitioner's reasonable business needs exceeded its net

liquid assets as shown below:

                             1987             1988          1989

      Herd expansion      $1,425,000       $1,575,000    $1,575,000
      Pollution control     50,000          550,000      1,000,000
      Equip./constr.       2,210,000       2,105,000     3,900,000
      Land                    0            1,500,000     2,000,000
      Debt retirement      3,300,000           0             0
      Self-insurance
      (herd)               3,300,000       3,900,000     3,900,000
      Working capital16       0             636,285       641,988
          Total           $10,285,000      $10,266,285   $13,016,988
      Net liquid
      assets:             $9,289,501       $10,141,109   $10,835,821

     Petitioner has also shown that it needed working capital and

at least some accumulations for self-insurance for liability;

however, in light of the foregoing, we need not separately

discuss these points.




     16
          As conceded by respondent.
                                 -51-

         We conclude that petitioner did not accumulate earnings and

profits beyond its reasonable business needs.       We concluded above

that petitioner was not formed or availed of to avoid income tax

on its shareholders.     See paragraph II-B-3.    Either conclusion

would justify our finding that the accumulated earnings tax does

not apply.     See Technalysis Corp. v. Commissioner, 101 T.C. 397

(1993).     Thus, we hold that the accumulated earnings tax does not

apply.

E.   Environmental Tax

     Respondent determined that petitioner was liable for the

environmental tax under section 59A in the amount of $1,177 for

the 1988 fiscal year.    Petitioner had the burden of proof, but

presented no evidence or argument on this issue.       Respondent

states that this issue is computational.    The parties should

resolve the amount petitioner owes in the Rule 155 computation.

F.   Negligence

     Respondent determined that petitioner is liable for

additions to tax for negligence for each of the years in issue.

Negligence is 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) (citing Marcello

v. Commissioner, 380 F.2d 499, 506 (5th Cir. 1967), affg. in part

and remanding in part 43 T.C. 168 (1964)).       Under section

6653(a)(1)(A) and (B) for fiscal years 1987 and 1988, and section
                               -52-

6653(a)(1) for fiscal year 1989, the addition to tax applies only

if there is an underpayment of tax as defined in section 6653(c).

     As discussed above, petitioner is not liable for the

accumulated earnings tax.   The only possible underpayment relates

to the environmental tax under section 59A.    Petitioner has

presented no evidence or argument as to whether any underpayment

of the environmental tax was reasonable.    Thus, if the Rule 155

computation shows that petitioner underpaid the environmental

tax, all of that underpayment is due to negligence.

     To reflect the foregoing and concessions,



                                           Decision will be entered

                                      under Rule 155.
