                       T.C. Memo. 2002-162



                     UNITED STATES TAX COURT



              LUCIAN T. BALDWIN, III, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent

  LUCIAN T. BALDWIN, III AND TERESA M. BALDWIN, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



    Docket Nos. 18739-95, 24410-95.     Filed June 26, 2002.



     Arnold A. Pagniucci, Paul D. Carman, Steven A. Miller,

Austin L. Hirsch, and Henry Pietrkowski, for petitioner Lucian T.

Baldwin III.

     John J. Morrison, for petitioner Teresa M. Baldwin.

     Marjory A. Gilbert, Catherine Thayer, and Claire McKenzie,

for respondent.
                                  - 2 -



                 MEMORANDUM FINDINGS OF FACT AND OPINION

       MARVEL, Judge:    In these consolidated cases, respondent

determined the following deficiencies, additions to tax, and

penalties in petitioners’ Federal income taxes:

Docket No. 24410-95
Lucian T. Baldwin III and Teresa M. Baldwin:

                                                          Accuracy-
                             Additions to tax          related penalty
Year       Deficiency   Sec. 6653(a)(1) Sec. 6661      Sec. 6662(a)

1988       $418,914         $20,946       $104,729           ---
1989        441,563           —              ---           $88,313


Docket No. 18739-95
Lucian T. Baldwin III:

                                                    Accuracy-
                                                 related penalty
       Year                  Deficiency           Sec. 6662(a)

       1990                   $660,180               $132,036
       1991                    627,605                125,521
       1992                    331,541                 66,308

       All section references are to the Internal Revenue Code in

effect for the years in issue, and all Rule references are to the

Tax Court Rules of Practice and Procedure.     Monetary amounts are

rounded to the nearest dollar.

       After concessions,1 the issues for decision are:


       1
      Respondent has conceded that petitioner Teresa M. Baldwin
(Mrs. Baldwin) qualifies for relief from joint liability under
sec. 6015. Other assignments of error raised in the petitions
and not addressed in the stipulations of settled issues or on
brief are deemed conceded. See Rule 151(e)(4) and (5); Petzoldt
v. Commissioner, 92 T.C. 661, 683 (1989); Money v. Commissioner,
                                                   (continued...)
                               - 3 -

     (1)   Whether Loma Farms, Inc. (LFI), an S corporation owned

by petitioner Lucian T. Baldwin III (petitioner) that purportedly

owned and managed a 5,000-acre lakefront lodge property known as

Granot Loma, operated a trade or business within the meaning of

section 162 or conducted an activity “not engaged in for profit”

within the meaning of section 183;

     (2) whether the duty of consistency or the doctrine of

equitable estoppel applies to bar petitioner’s contention that

Baldwin Aircraft Corp. (BAC) was not a valid S corporation during

the years at issue;

     (3) if the duty of consistency or the doctrine of equitable

estoppel applies to bar petitioner’s contention, whether BAC

operated a trade or business within the meaning of section 162,

or whether BAC conducted an activity “not engaged in for profit”

within the meaning of section 183;

     (4) whether deductions for lodging and travel expenses

claimed by Baldwin Commodities Corp. (BCC), for 1990, 1991, and

1992, are allowable under sections 162 and 274; and

     (5) whether petitioner is liable for the additions to tax

and penalties determined by respondent.




     1
      (...continued)
89 T.C. 46, 48 (1987).
                               - 4 -

                          FINDINGS OF FACT

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

The stipulation of facts and supplemental stipulations of facts

are incorporated in this opinion by this reference.

Background

     At the time the petitions in these cases were filed,

petitioners, who were married to each other during the years at

issue, were no longer married and resided separately in Winnetka,

Illinois.

     Petitioner received his bachelor of science degree from

Santa Clara University.   He subsequently obtained a master of

business administration degree with emphasis in agribusiness.

Petitioner also attended law school for two semesters on a part-

time basis.

     Petitioners were married in 1978.   They have three children:

Christina, Jane, and Lucian, born in 1982, 1986, and 1987,

respectively.   In September of 1990, petitioners separated, and

in late 1990, a petition for divorce was filed.   In 1993,

following a hotly contested trial involving multiple issues

concerning the ownership of property, a judgment of dissolution

was entered, and petitioners’ divorce became final.

Petitioner’s Bond Trading Activities and Other Business Ventures

     Petitioner has been a bond trader at the Chicago Board of

Trade since 1982.   From 1987 through 1989, petitioner traded as a
                                - 5 -

sole proprietor under the name of Baldwin Commodities (BC).   In

1990, petitioner incorporated the proprietorship and became sole

shareholder of BCC, an S corporation.

     During the years at issue, petitioner was a very successful

trader in the bond pit at the Chicago Board of Trade.

Petitioner’s success was due, at least in part, to his financial

resources, reputation, and relationships with brokers and other

traders in the bond pit.    His financial resources enabled him to

trade with brokers representing institutional clients and other

traders with large volume orders.

     In 1987, petitioner earned $19,160,059 from his bond trading

activity.    During the years at issue, the amount of time

petitioner spent in the bond pit decreased as a result of his

marital problems and the divorce litigation, as well as health

problems that followed a plane crash in November 1991.

Petitioner’s income from bond trading during the years at issue

was as follows:

                  Year                    Income

                  1988                  $7,254,066
                  1989                   4,570,760
                  1990                   5,269,504
                  1991                   4,134,403
                  1992                   3,045,776

     During the years at issue, petitioner began to diversify his

business and investment interests and formed several new

companies.    For example, in December 1988, petitioner purchased
                               - 6 -

the Rookery Building on LaSalle Street in Chicago and formed two

real estate companies, Baldwin Development Corp. (BDC) and

Baldwin Asset Management Co. (BAMCo.), to restore and manage the

Rookery Building.   In May 1989, petitioner incorporated Baldwin

Financial Corp. (BFC).   BFC was registered with the Commodity

Futures Trading Commission as a commodity pool operator and a

commodity trading adviser.   In 1992, petitioner formed a New York

general partnership named MC Baldwin Financial to continue BFC’s

business as a commodity pool operator and commodity trading

adviser.

Granot Loma

     During 1986 and 1987, petitioners looked sporadically for a

vacation home.   Petitioner first learned of the existence of

Granot Loma in 1987.   During a family vacation in 1987,

petitioners, accompanied by their children and Mrs. Baldwin’s

brother, Pat Matre, and his family, drove to see the property.

     Granot Loma consisted of approximately 5,000 acres,

including 4 miles of Lake Superior shoreline.   There were two

complexes of buildings at Granot Loma, the large log cabin lodge

with its associated outbuildings and the old farm complex.    A

separate small log cabin which was the original depot for the

railroad spur that once serviced the property was also located on

the property.
                                - 7 -

     The lodge complex was located on Lake Superior and consisted

of the large log cabin lodge, a garage, a child’s playhouse, a

separate building called the maid’s quarters, a carriage house,

and a guest house.    The lodge at Granot Loma had 22 bedrooms

arranged in 10 suites.    Because the lodge was sited on a small

peninsula, many of the lodge’s rooms faced Lake Superior.2

     The old farm complex was located down the road from the

lodge complex and consisted of a farmhouse, a caretaker’s house,

a barn, a piggery, a manure house, a slaughterhouse, a creamery

which had been converted to a pool house prior to 1987, and a

pheasant/pigeon house.    The farmhouse and the caretaker’s house

were both habitable residences in 1987.    The garage, pool house,

and depot were the only other buildings in usable condition in

1987.    The remaining buildings were all in need of substantial

repairs, renovation, and cleaning.

     The area around Granot Loma was essentially a wilderness

area.    The property was forested and contains mature stands of

hemlock, maple, pine, birch, cedar, spruce, and poplar.    Included

in its acreage was over a mile of frontage on the Little Garlic



     2
      The lodge was built in the 1920s by financier Lewis Kaufman
in the style of an Adirondack camp. Visitors during the 1920s
and 1930s included Governor Al Smith, actress Mary Pickford, and
the pianist and composer George Gershwin. The deal to build the
Empire State Building was finalized at Granot Loma. By 1987,
however, when petitioner purchased Granot Loma, the grand days of
Granot Loma were long over; no one had lived in the lodge for
decades.
                                - 8 -

River, considered to have some of the finest rainbow trout

fishing in the State of Michigan.

     Since at least November 1992, Granot Loma’s frontage area

has been zoned for recreational structures, the farm area has

been zoned for rural residential, another area has been zoned for

resource production, and the remaining acreage has been zoned for

timber production.3

Petitioners’ Acquisition of Granot Loma

     When petitioners’ family and the Matre family first visited

Granot Loma in 1987, the two families toured the property with

caretaker George Johnson.    During the tour, petitioner, Mrs.

Matre, and Mr. Johnson discussed numerous issues, including the

history and use of Granot Loma, other potential buyers of the

property, and potential business uses of the property, such as

for a corporate retreat.    Mr. Johnson also suggested selective

logging of the valuable maple trees that grew on the property, as

well as other ventures, such as a hunting club that could take

advantage of the property’s natural resources.

     When petitioner first viewed the lodge, he thought the

property could be restored to its former grandeur.    Within a few

days of their first visit, petitioners decided to purchase Granot

Loma, and the transaction closed on October 1, 1987.    Petitioners


     3
      The record does not reflect the types of activities that
would have been allowed by local zoning laws as of the time of
purchase, or how they changed, if at all, through November 1992.
                               - 9 -

paid $4,380,000 for Granot Loma and took title to the property as

tenants by the entireties.4

     Around the time of Granot Loma’s purchase, petitioner

discussed with Eugene Portman, an attorney who specialized in

real estate law, the creation of several corporate entities to

house several new businesses and investments petitioner was

acquiring in an attempt to diversify his assets.   Mr. Portman

handled Granot Loma’s closing and associated preclosing matters

for petitioner.

     On April 14, 1988, Mr. Portman filed articles of

incorporation with the Illinois secretary of state for a company

that was later renamed Loma Farms, Inc. (LFI).   The articles

stated that the company was formed for the purpose of “engaging

in the business of * * * property manager and convention, hotel

and resort manager.”   Petitioner was LFI’s sole shareholder.

Petitioner’s Restoration of Granot Loma

     Petitioner engaged Mr. Matre as his general contractor for

the restoration of Granot Loma.   In exchange for Mr. Matre’s

services, petitioner promised him 10 percent of any profit upon

the sale of Granot Loma and free use of the property when space

was available.




     4
      This amount includes $125,000 paid to George and Carmen
Johnson to purchase the depot property.
                                - 10 -

     Because petitioner thought he might use Granot Loma as a

lodge or corporate retreat at some point, his plan for the

restoration included commercial amenities.    For example,

petitioner renovated and equipped the kitchen so that up to 150

guests could be accommodated.    Petitioner installed a commercial

bar system which dispensed metered shots of liquor and soda

through hoses from a basement storage area.    Furthermore,

heating, electrical, and other major systems were all built to

withstand and support commercial use.

     In many other respects, however, Granot Loma’s restoration

also reflected petitioners’ intent to use it as a personal

residence for their immediate and extended family, their friends,

and other invited guests.   For example, although the renovation

of the kitchen included the installation of commercial grade

equipment and systems, the kitchen was designed so that it easily

could be used by petitioners and their family and friends when

they visited Granot Loma.   Petitioners’ renovation of the kitchen

included a greenhouse addition which was used as a family dining

area.   When Mrs. Baldwin decorated the lodge with help from an

interior decorator, she decorated the lodge to be her family

home.   Thus, the second floor of the lodge housed a nursery, a

children’s play area, a media room, a home office, and a master

bedroom for petitioners, along with several other bedrooms used
                                - 11 -

for petitioner’s children, Mr. Matre and his family, and other

regular guests.

     Renovation of the lodge began in the spring of 1988 and was

substantially completed by the end of that year.    The lodge,

however, was not habitable until March 1989 when furniture was

first moved into the lodge.    During the renovation period,

petitioner and his family visited on a weekly or biweekly basis

so that petitioner could supervise the contractors and his family

could enjoy the property.    Until the lodge was habitable,

petitioner’s family and Mr. Matre’s family stayed in the

farmhouse.

     The cost of capital improvements to Granot Loma from October

1, 1987, through December 31, 1992, totaled $2,504,794.

Petitioners’ Use of Granot Loma

     Before acquiring Granot Loma, petitioners took vacations to

various locations around the world, including long trips on

holidays.     From the date they acquired Granot Loma through August

1990, petitioners spent almost every holiday at Granot Loma.

     During the years at issue, petitioners and their family

personally used Granot Loma as follows:

             Year                     Days Used

             1988                         68
             1989                         79
             1990                         71
             1991                         66
             1992                         51
                               - 12 -

Granot Loma’s most frequent visitors were petitioners, their

children, and other family members.     Other visitors during the

years at issue included personal friends, business associates,

and pilots.    On several occasions, petitioners’ extended families

joined them at Granot Loma.

     While at Granot Loma, petitioners and their guests

participated in recreational activities such as riding all-

terrain vehicles (ATVs), snowmobiling, skiing, hunting, boating,

and fishing.   Petitioners kept two small ATVs at Granot Loma for

their children to ride, and three to four full-size ATVs.

Petitioners also kept snowmobiles at Granot Loma.     When

petitioners first purchased Granot Loma, their children were

young; the children played, swam, rode on ATVs and snowmobiles,

and otherwise participated in normal childhood activities.

Petitioner participated in many activities with his children,

and, even on days when petitioner was out hunting or fishing, the

family ate meals together and played together in the evenings.

     Petitioners’ children left toys, bicycles, and clothing at

Granot Loma when they returned to Winnetka.     Petitioners used the

master suite at Granot Loma as their bedroom and office until

they separated.   Mrs. Baldwin left her personal belongings in the

master bedroom when she returned to Winnetka.     After his

separation from Mrs. Baldwin in 1990, petitioner spent many

weekends and holidays with his children at Granot Loma.
                                - 13 -

     Throughout the years at issue, petitioner insured Granot

Loma as his second residence.    Petitioner also insured all the

recreational vehicles at Granot Loma; i.e., boats, personal

watercraft, and snowmobiles, as his personal property.

     Petitioner occasionally discussed investments or other

business matters while at Granot Loma.    Petitioner also

entertained family members and friends with whom he did business,

as well as employees, traders, brokers, and other business

associates, at such events as annual employee weekends and trader

weekends.

     From time to time, petitioner investigated possible business

uses for Granot Loma.   For example, in 1989, petitioner decided

to plant Christmas trees on the property.5    Also, in 1989,

following a vicious winter storm, petitioner engaged a logging

company to remove some storm-damaged trees.    Sometime later,

petitioner hired a contractor to conduct a selective timber

harvesting program on a limited trial basis.    In approximately


     5
      The Marquette County Soil and Water Conservation District
was consulted to determine the optimum locations for planting the
trees. Petitioner rejected the Conservation District’s first
choice for siting the trees, as he wanted to keep that field
available for a runway. Petitioner ultimately decided to plant
the Christmas trees along the driveway, a site not recommended by
the Conservation District. In the year following their planting,
approximately one-half of the newly planted trees died because
their roots had not been clipped prior to planting. The burden
of digging up the dead trees and replanting was deemed to exceed
any expected benefit, so the Christmas tree operation was
abandoned. None of the Christmas trees planted at Granot Loma
ever generated any income.
                              - 14 -

1990, Granot Loma’s caretaker and his wife experimented with some

maple syrup equipment they found on the property to tap some of

the maple trees growing on the property and process the sap into

syrup.   They ceased the experiment, however, after the

caretaker’s wife received burns as a result of their activity.

     In February 1989, petitioner hired Joseph Ketter as

caretaker and property manager for Granot Loma.   When Mr. Ketter

was hired, he was informed that petitioner intended to use Granot

Loma as a business retreat.   At some point after he was hired,

Mr. Ketter was instructed to issue an invoice in LFI’s name to

one of petitioner’s other corporations each time petitioners, a

member of their family, or one of their friends, business

associates, or guests visited Granot Loma.   For example, the

first invoice for $420, dated March 7, 1989, was addressed to BAC

and covered three nights for two pilots at a rate of $70 per

person per night.   Another invoice, dated August 9, 1989, for

$5,530 was addressed to BCC, reflecting the overnight stays of

petitioner’s employees during the 1989 employee weekend, at the

same rate.    One invoice for $123,285, dated April 23, 1990,6 was

addressed to BCC and retroactively billed BCC for visits by

petitioner, his family, and their guests during 1988, 1989, and



     6
      Petitioner’s accountant, Mr. DiMaggio, was first contacted
by a representative of the Internal Revenue Service regarding the
examination at issue in this case in April 1990.
                               - 15 -

the early part of 1990.   From March 1990 through the end of 1992,

LFI billed BCC for every night petitioner, a member of his

family, one of his business acquaintances, or one of his friends

stayed at Granot Loma.

     LFI did not bill any of the guests directly; all invoices

were sent either to BCC, BDC, or BAC.    In fact, almost none of

the guests were even aware that LFI was charging anyone for their

stay.    Even Mrs. Baldwin was not aware of LFI’s invoicing system

until the divorce proceedings commenced.

     No rooms at Granot Loma were ever held out to the public for

rent, and no rooms were ever rented to the public.7   No leases or

rental contracts for the rental of Granot Loma were executed by

LFI, any guest, or any of petitioner’s other companies.    Only

petitioner’s relatives, friends, business acquaintances, and

other invited guests used Granot Loma.    In fact, petitioners

decided not to operate Granot Loma as a commercial lodge because

they did not want to curtail their use of the facility or to open

it up for use by guests they had not invited personally.

     When Mr. Ketter set the rental rates for Granot Loma, he did

not estimate an occupancy rate, project the frequency of use, or


     7
      In September 1989, Worth Brown, a resort manager, visited
Granot Loma for the purpose of determining whether Granot Loma
could be operated as a luxury resort. He concluded that it was
possible. Petitioners, however, decided not to commence a bed
and breakfast or other business open to the public because they
did not want to share the lodge with outsiders. Granot Loma was
never operated as a commercial lodge.
                              - 16 -

conduct any market studies.   The initial per-night rate of $70

per person purportedly covered lodging and meals and did not vary

by room.   Mr. Ketter increased the per-night rate to $125 per

person in August 1989, to $175 per person on January 1, 1991, and

to $200 per person on January 1, 1992.   Visitors to Granot Loma

enjoyed, for no additional charge, the Disney channel and other

entertainment channels, babysitters, shotgun shells, archery

targets and arrows, dry cleaning, and a variety of other items of

a personal nature.

     All of LFI’s purported rental income came from BCC and other

companies owned or controlled by petitioner.   The income,

however, was insufficient to cover LFI’s alleged expenses.    LFI’s

cashflow deficits were funded through a shareholder’s loan

account, thus ensuring that Granot Loma had adequate cashflow to

cover expenses.   BCC paid some of LFI’s invoices by intercompany

account transfers; others were paid by reducing LFI’s

indebtedness to BCC.

     In the summer of 1990, petitioners held an auction to sell

off furniture and rugs at the lodge that had not been used in the

restoration.   The auction raised a total of $309,386.   The net

proceeds were applied to reduce LFI’s debt to BCC.8



     8
      In a stipulation of settled issues, the parties agreed that
petitioner had additional capital gains of $261,889 arising from
the auction sale and that the auction sale proceeds were not
ordinary income to LFI.
                               - 17 -

Petitioner’s Attempt To Sell Granot Loma

      In 1989, petitioner decided to sell Granot Loma.    His

decision to do so was influenced by his marital problems and a 1-

day trading loss of approximately $5 million.     In early 1990,

Gary Walker, an appraiser, valued the property in excess of $10

million.   On April 30, 1990, after discussions and negotiations

with several real estate brokers, petitioner listed Granot Loma

with a broker for an asking price of $12 million.     Although the

property generated considerable interest, no reasonable offers

were received.   Petitioner renewed the listing once and then

allowed it to expire during 1991.

      On his financial statement dated May 31, 1992, petitioner

reported the value of his interest in LFI as $4,551,888.     During

the pendency of his divorce, petitioner obtained an appraisal of

Granot Loma that valued the fee simple interest in the property,

as of July 28, 1992, at $3,800,000.     That appraisal identified

petitioners as the owners of Granot Loma.

BAC

      On May 20, 1988, petitioner purchased a Beechcraft King Air

200 (King Air) and formed BAC to own and operate the King Air.

Articles of incorporation for BAC were prepared and filed in

North Carolina the same day.   On August 24, 1988, BAC traded its

King Air for a Sabreliner jet (the Sabre). Petitioner hired

professional pilots to fly the Sabre.
                              - 18 -

     BAC’s S Election

     Mr. Portman recommended that BAC be owned by Mrs. Baldwin in

order to protect petitioner’s trading business from liability in

the event of an accident and informed petitioner’s accountant

that Mrs. Baldwin would own BAC.   Mr. Portman prepared BAC’s Form

2553, Election by a Small Business Corporation (Under section

1362 of the Internal Revenue Code), and sent the Form 2553 to

petitioner with instructions for Mrs. Baldwin to sign as sole

shareholder.   However, Mrs. Baldwin did not sign the form and did

not consent to BAC’s election to be treated as an S corporation.

Instead, Liz Matre signed Mrs. Baldwin’s name (as consenting

shareholder and as president of BAC) on the form.   Respondent

accepted the facially complete Form 2553 on May 31, 1988.

     BAC’s 1988 and 1989 Forms 1120S, U.S. Income Tax Return for

an S Corporation, list Mrs. Baldwin as BAC’s sole shareholder.

BAC’s 1990, 1991, and 1992 Forms 1120S, which were filed after

petitioners’ divorce proceeding had commenced, list petitioner as

BAC’s sole shareholder.

     BAC’s Transportation Activity

     During the years at issue, petitioner regularly used the

Sabre to transport himself and his family, friends, and other

invited guests to Granot Loma.   In an effort to structure the

operation of BAC as a business, petitioner, beginning in

approximately May 1989, arranged for BAC to invoice one of his
                               - 19 -

other companies each time the Sabre was used.   From 1989 through

and including 1992, BAC billed one of petitioner’s companies for

each person transported, using a per capita rate established by

BAC’s president after consultation with petitioner.9   The per

capita rate used to prepare the invoices was increased in 1989,

1990, and 1991 in an effort to reduce BAC’s substantial operating

losses.

     BAC claimed depreciation on the Sabre, which was titled in

BAC’s name, and on a Cessna, which was not titled in BAC’s

name.10   Petitioner acquired the Cessna ostensibly so that he

could obtain his pilot’s license and eventually fly the Sabre.

     During the years at issue, BAC did not offer the Sabre for

charter by third parties, nor did it lease the Sabre to a third

party; BAC used the Sabre to provide transportation exclusively

to petitioners, their family, and invited guests.




     9
      After November 1990, BAC did not include passenger names
other than petitioner’s in the aircraft utilization reports and
trip recaps maintained by BAC. In addition, BAC did not maintain
any records regarding the nature of the trips taken on its
aircraft.
     10
      Record title to the Cessna was apparently held by a
separate corporation, Lucian Aircraft Co., which insured the
Cessna until 1991. Petitioner’s accountant testified that BAC
claimed depreciation on the Cessna because BAC should have owned
the Cessna. Certain records in evidence show that the Cessna was
rented on three occasions during 1990 by people who were or had
been employed as BAC’s pilots.
                                      - 20 -

Tax Reporting

          LFI

          On a Schedule F, Farm Income and Expenses, attached to

petitioners’ 1987 Federal income tax return Form 1040,

petitioners represented that Granot Loma was a Christmas tree

farm and claimed a depreciation deduction of $163,781 with

respect to personal property with a book value of $1 million and

improvements with a book value of $2,255,000.

          On LFI’s Forms 1120S for 1988 through 1992, LFI reported the

following income, expenses, and net operating losses:
                          1988         1989      1990        1991        1992
Income:
Lodging                    -0-      $16,290     $233,285    $154,373    $124,148
Tree removal                          8,135
Auction                                         305,567
Less:   Refunds                      (1,414)
Other income                          2,936       6,024                   3,000
Total income               -0-       25,947     544,876     154,373     127,148
Expenses:
Salaries & wages        $284,437    144,996      89,153      80,192      33,908
Repairs                              14,225                  30,771      12,758
Bad debts                                                     9,958
Rents                                             2,000                   2,856
Taxes                                71,134     139,297      58,494      80,155
Depreciation             307,422    379,204     363,126     314,419     275,043
Employee benefits                    11,084                  21,732       6,839
Other expenses           375,147    301,289     403,580     239,342     176,417
Total expenses           967,006    921,932     997,156     754,908     587,976
Net income or (loss)    (967,006)   (895,985)   (452,280)   (600,535)   (460,828)


          BAC

          On BAC’s Forms 1120S for 1988 through 1992, BAC reported the

following income, expenses, and net operating losses:
                                      - 21 -
                         1988        1989        1990        1991         1992
 Income:
 Rental income          $168,400    $179,406    $109,185    $221,563     $200,390
 Other income                        16,148
 Total income           168,400     195,554     109,185     221,563       200,390
 Expenses:
 Salaries & wages                    31,778      48,627      40,260       40,000
 Repairs                             87,433
 Rents (Hangar)           7,618      12,345      16,208      18,310       17,826
 Taxes                               18,694       4,561       3,166        3,612
 Depreciation            86,502     322,667     194,240     116,583       108,057
 Employee benefits                    4,408                     108
 Other expenses         269,890     169,331     374,463     424,697       316,743
 Total expenses         364,010     646,656     638,099     603,124       486,238
 Net income or (loss)   (195,610)   (451,102)   (528,914)   (381,561)    (285,848)




         Accountant’s Role

         Throughout the years at issue, petitioner utilized the

services of Victor DiMaggio, a certified public accountant.                          Mr.

DiMaggio provided consulting services to petitioner with respect

to LFI and BAC, prepared LFI’s, BAC’s, BCC’s, and petitioners’

tax returns, and helped LFI’s and BAC’s employees set up and

maintain the books and records for those companies.                     Mr. DiMaggio

also advised petitioner individually regarding some tax matters.

Petitioner instructed his employees to contact Mr. DiMaggio

directly whenever they had any tax-related questions.

         At some point before he prepared petitioner’s 1989 return,

Mr. DiMaggio warned petitioner that LFI and BAC may be activities

not engaged in for profit and that, therefore, the losses

attributable to those activities may be disallowed under section

183.       In addition, in the course of preparing BCC’s tax returns

for the years at issue, Mr. DiMaggio estimated that a substantial

portion of the amounts billed to BCC by LFI and BAC for 1990,

1991, and 1992 were attributable to petitioner’s personal use of
                                - 22 -

Granot Loma and the aircraft.    Specifically, Mr. DiMaggio

estimated that 90 percent of the amounts billed in 1990 and 75

percent in 1991 and 1992 by LFI and BAC were attributable to

petitioner’s personal use of Granot Loma and the aircraft.

The Audit and Notices of Deficiency

     In April 1990, Mr. DiMaggio was first contacted about the

audit of petitioners’ returns.    In September 1990, Jean Witek,

the revenue agent assigned to audit petitioners’ returns, sent

the initial audit letter to petitioners.

     In 1991, during the pendency of petitioners’ divorce case,

counsel for Mr. and Mrs. Baldwin argued in court about which

party owned BAC (the ownership dispute).    Mr. DiMaggio claimed

that Ms. Witek observed these arguments and subsequently referred

to the ownership dispute in conversations with him.11

     The audit eventually was completed without any change to

BAC’s S corporation status.   During the appeals process, Mr.

DiMaggio never mentioned the ownership dispute, nor did he raise

any issues concerning the validity of BAC’s S election with any

of respondent’s Appeals officers or other agents.   The protest

documents filed by Mr. DiMaggio represented, indirectly, that BAC

was a valid S corporation; i.e., he maintained that petitioners

were entitled to deduct BAC’s passthrough losses.


     11
      According to Mr. DiMaggio, he and Ms. Witek agreed to
defer consideration of the ownership dispute until the end of the
audit. Unfortunately, Ms. Witek was unable to complete the audit
because of illness.
                               - 23 -

     Respondent proposed numerous adjustments in the notices of

deficiency, most of which have been resolved.    For each year at

issue with respect to BAC, respondent disallowed all of BAC’s

expenses and recalculated BAC’s income accordingly, determined

that petitioner must include in his income BAC’s corrected S

corporation income, and allowed petitioner additional Schedule A

miscellaneous deductions in amounts equal to BAC’s corrected S

corporation income, presumably pursuant to section 183(b).12    For

1988, 1991, and 1992 with respect to LFI, respondent disallowed

petitioner’s deductions of LFI’s distributive net losses.    For

1989, respondent disallowed all of LFI’s deductions and

determined that petitioner must include in income LFI’s corrected

S corporation income but did not make any adjustment under

section 183(b) except with respect to Granot Loma’s real estate

taxes.    For 1990, respondent reclassified LFI’s net auction

proceeds as capital gain to petitioner, disallowed all of LFI’s

deductions, and determined that petitioner must include in income

LFI’s corrected S corporation income but did not make any

adjustment under section 183(b) except with respect to Granot

Loma’s real estate taxes.




     12
      By disallowing petitioner’s deductions of BAC’s losses,
respondent effectively allowed petitioner the adjustment required
by sec. 183(b).
                              - 24 -

                              OPINION

I.   LFI Issues

      In a far-ranging and sometimes unfocused attack on LFI,

respondent, in his notices of deficiency, asserted numerous

grounds for disallowing LFI’s deductions and recalculating LFI’s

distributive net income for the years at issue:   (1) Petitioner

has not established the amounts in question were paid or incurred

in a trade or business; (2) Granot Loma was never transferred to

LFI by petitioners and, therefore, LFI is not entitled to

depreciate Granot Loma; (3) petitioner has not established that

he was at risk with respect to LFI; (4) petitioner has not

established that “the activity” was entered into for profit; (5)

petitioner has not established that “the transaction” had

economic substance; (6) petitioner has not established that the

claimed losses were incurred or were otherwise allowable; and (7)

petitioner has not established that “the amounts claimed as

payments were paid, and if paid, were for the purpose as stated.”

      Although the parties devoted most of their arguments on

brief to the issue of whether LFI was a trade or business under

section 162 or an activity not engaged in for profit within the

meaning of section 183, the parties also addressed the other

grounds raised in the notices of deficiency as well as an

additional argument under section 280A that was not enumerated

in, or expressly raised by, the notices of deficiency.   Because

we believe that the issue regarding the proper tax treatment of
                                 - 25 -

LFI’s income, deductions, and losses may be appropriately

resolved by applying sections 162 and 183, we direct our analysis

accordingly.

     A.   Sections 162 and 183

     Under section 162, a taxpayer may deduct the ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on his trade or business.        A taxpayer is engaged in a

trade or business if the taxpayer is involved in the activity (1)

with continuity and regularity, and (2) with the primary purpose

of making a profit.   Commissioner v. Groetzinger, 480 U.S. 23, 35

(1987); Antonides v. Commissioner, 893 F.2d 656, 659 (4th Cir.

1990), affg. 91 T.C. 656 (1988).

     Petitioner has the burden of proving that LFI was engaged in

a trade or business and that LFI is entitled to the deductions

claimed.13   Rule 142(a); INDOPCO, Inc. v. Commissioner, 503 U.S.

79 (1992); New Colonial Ice Co. v. Helvering, 292 U.S. 435

(1934); Welch v. Helvering, 290 U.S. 111 (1933).        If petitioner

fails to establish LFI’s entitlement to the deductions under




     13
      The Internal Revenue Service Restructuring & Reform Act of
1998, Pub. L. 105-206, sec. 3001, 112 Stat. 726, added sec.
7491(a), which is applicable to court proceedings arising in
connection with examinations commencing after July 22, 1998.
Under sec. 7491, Congress requires the burden of proof to be
placed on the Commissioner, subject to certain limitations, where
a taxpayer introduces credible evidence with respect to factual
issues relevant to ascertaining the taxpayer’s liability for tax.
In the instant case, petitioners have not raised the application
of this provision. Further, the record indicates that the
Commissioner’s examinations commenced before July 22, 1998.
                              - 26 -

section 162,14 and fails to show error in respondent’s

determination that LFI was engaged in an activity not for profit,

then section 183 limits LFI’s deductions for expenses

attributable to the activity, as provided in section 183(b).

     In order to establish that LFI engaged in an activity for

profit, petitioner must show he entertained an actual and honest

profit objective15 in engaging in the activity, even if that

objective was unreasonable or unrealistic.   Burger v.

Commissioner, 809 F.2d 355, 358 (7th Cir. 1987), affg. T.C. Memo.

1985-523; Surloff v. Commissioner, 81 T.C. 210, 233 (1983);

Dreicer v. Commissioner, 78 T.C. 642, 644-645 (1982), affd.

without opinion 702 F.2d 1205 (D.C. Cir. 1983); sec. 1.183-2(a),

Income Tax Regs.   Although section 183 applies at the corporate

level with respect to the activities of an S corporation, sec.

1.183-1(f), Income Tax Regs., we consider the intent of

petitioner, LFI’s sole shareholder, in deciding whether LFI had

the requisite profit objective, see Eppler v. Commissioner, 58


     14
      Sec. 183(c) provides that a taxpayer is engaged in an
activity not for profit if the activity is one other than “one
with respect to which deductions are allowable for the taxable
year under section 162 or under paragraph (1) or (2) of section
212.” Petitioner argues for the first time on brief that LFI is
entitled to deduct its expenses under sec. 212 if we conclude
that LFI did not operate a trade or business for profit under
sec. 162. Respondent objects to this argument as untimely raised
and prejudicial. We agree with respondent and decline to
consider petitioner’s argument under sec. 212. Estate of
Gillespie v. Commissioner, 75 T.C. 374 (1980).
     15
      Petitioner bears the burden of proving that he had the
requisite profit objective. Rule 142(a).
                                - 27 -

T.C. 691, 696-699 (1972), affd. without published opinion 486

F.2d 1406 (7th Cir. 1973); Butler v. Commissioner, 36 T.C. 1097

(1961).

     In determining whether the requisite intention to make a

profit exists, greater weight is to be given to the objective

facts than to the taxpayer’s self-serving characterization of his

intent.   Dreicer v. Commissioner, supra at 645; sec. 1.183-2(a),

Income Tax Regs.   Section 1.183-2(b), Income Tax Regs., sets

forth a nonexclusive list of factors to be considered in

determining whether the taxpayer has the requisite profit

objective.   The factors are:   (1) The manner in which the

taxpayer carries on the activity; (2) the expertise of the

taxpayer or his advisers; (3) the time and effort expended by the

taxpayer in carrying on the activity; (4) the expectation that

assets used in the activity may appreciate in value; (5) the

success of the taxpayer in carrying on other similar or

dissimilar activities; (6) the taxpayer’s history of income or

loss with respect to the activity; (7) the amount of occasional

profits, if any, that are earned; (8) the financial status of the

taxpayer; and (9) elements of personal pleasure or recreation.

No single factor is determinative, and not all factors are

applicable in every case.   Burger v. Commissioner, supra at 358

n.4; Allen v. Commissioner, 72 T.C. 28, 34 (1979); sec. 1.183-

2(b), Income Tax Regs.
                              - 28 -

     Respondent contends that petitioner used Granot Loma as a

residence, and that LFI did not own Granot Loma and did not

operate a trade or business or otherwise engage in any activity

for profit during the relevant years.   As we understand it,

petitioner’s argument is that, from the date petitioners

purchased Granot Loma, Granot Loma was a business asset that

petitioner and then LFI used in one or more business activities

for profit.   The activities that petitioner alleges he or LFI

conducted for profit at Granot Loma include a Christmas tree

farm, a timbering operation, a maple syrup operation, and a

rental activity.   Petitioner also alleges that petitioners and/or

LFI acquired Granot Loma with the intent of renovating and

operating it as a commercial property or selling it for a profit.

For the reasons set forth below, we agree with respondent.

     From the time petitioner and his wife purchased Granot Loma

in 1987, petitioner was determined to claim that Granot Loma was

a business and began to deduct Granot Loma’s expenses, initially

for 1987 on a Schedule F, and then through LFI, an S corporation.

For 1988, petitioner, through LFI, claimed deductions for

depreciation of Granot Loma buildings and improvements (including

the lodge which was uninhabitable and in the process of being

renovated), other alleged operating expenses, and some of the

expenses incurred in renovating the lodge, claiming that Granot

Loma was an operating Christmas tree farm.   For 1990 through
                              - 29 -

1992, petitioner, through LFI, claimed that Granot Loma was used

exclusively for business, and continued to depreciate Granot Loma

buildings and improvements, to deduct all of Granot Loma’s

alleged operating expenses, and to report as lodging income

amounts paid or credited to LFI by petitioner’s other companies.

On his Federal income tax returns for 1988 through 1992,

petitioner deducted passthrough losses from LFI in the aggregate

amount of $3,376,634.

     In support of LFI’s aggressive writeoff of Granot Loma,

petitioner asserts that LFI maintained extensive books and

records, experimented with and abandoned unprofitable activities,

and consulted with various experts regarding the renovation of

Granot Loma as a commercial facility.   Petitioner also contends

that he devoted considerable time and effort to the renovation

and operation of Granot Loma, that he regularly used Granot Loma

for business meetings throughout the years at issue, and that he

intended, among other things, to sell Granot Loma at a profit.

     We first examine the activities in which LFI allegedly

engaged in order to ascertain whether any of those activities

were conducted with sufficient continuity and regularity to

satisfy the threshold test for a trade or business.   Petitioner

contends that Granot Loma was the site of an operating Christmas

tree farm, a timbering operation, a maple syrup operation, and a

rental activity.   In connection with the lodge, LFI also sold at
                              - 30 -

auction during 1990 various personal property that was not used

in the lodge renovation and claimed the auction proceeds as

business income.

     Although there were isolated episodes in which LFI began to

explore possible money-making ventures, these activities never

materialized into a real business venture, either individually or

collectively.   For example, the Christmas tree operation, which

began with the planting of trees in 1989, was abandoned within a

year after the initial planting because over half of the trees

planted had died.   Similarly, the experiment with maple sugaring

was abandoned after LFI’s caretaker’s wife suffered burns during

the processing of the sap.   The timbering operation likewise

never got past the exploratory stage.    The auction was a one-time

sale of excess furnishings that were not used in the renovation

of the lodge and, under the circumstances, was the functional

equivalent of a garage sale, only on a larger scale.    “Carrying

on a trade or business” requires a showing of more than initial

research into or investigation of business potential.    Frank v.

Commissioner, 20 T.C. 511, 513 (1953).    None of the above-listed

activities, either individually or collectively, were conducted

with continuity or regularity and, hence, do not constitute a

trade or business for purposes of section 162.   See Commissioner

v. Groetzinger, 480 U.S. at 35.
                               - 31 -

     The only activity allegedly conducted by LFI that warrants

detailed examination under sections 162 and 183 is the alleged

rental of the lodge.   Beginning in 1989 and continuing throughout

the remaining years at issue, LFI billed one of petitioner’s

other companies for every night spent at Granot Loma by

petitioners and their family, friends, and business

acquaintances.16   LFI arguably conducted this activity, variously

characterized by petitioner as a rental business or as the

operation of a corporate retreat or lodge, with sufficient

continuity and regularity from 1989 through at least 1992 that an

examination of whether the activity was conducted with the intent

to make a profit is appropriate.   In making the examination, we

apply the factors of section 1.183-2(b), Income Tax Regs.

     The factors on which petitioner primarily relies in support

of his argument that petitioner’s and LFI’s use of Granot Loma

was an activity for profit are the manner in which petitioner and

LFI operated Granot Loma, the expertise of petitioner and his

advisers, the amount of time and effort petitioner devoted to

Granot Loma, and petitioner’s expectation that Granot Loma would

appreciate in value and ultimately be sold at an economic profit.

     The factors on which respondent primarily relies in support

     16
      In 1990, after petitioner’s accountant raised concerns
about LFI’s ability to withstand scrutiny under sec. 183,
petitioner arranged for Granot Loma’s caretaker to bill for each
time petitioner, his family, and his guests stayed overnight at
Granot Loma during 1988, 1989, and the early part of 1990.
                              - 32 -

of his argument that petitioner’s and LFI’s use of Granot Loma

was not an activity for profit are the substantial history of

losses generated by the alleged business activity, the complete

lack of any profits from the activity over a 6-year period,

petitioner’s financial status during the years at issue, and the

personal pleasure and recreation derived by petitioners from

their use of Granot Loma.

     The record in this case reveals that petitioners purchased

Granot Loma and renovated the lodge and other parts of the

property, in part, for possible commercial use in the future.    In

so doing, petitioner consulted with advisers regarding equipment

and systems to be installed in the lodge and around the property

to support commercial use.   The record also reveals, however,

that the renovation was designed to enable petitioner and his

family to use Granot Loma as their residence.

     Whatever petitioner’s intention might have been regarding

the operation of Granot Loma as a commercial property at some

point in the future, the evidence convinces us that Granot Loma

was purchased primarily for use as petitioners’ residence and it

was used primarily as a residence; i.e., as petitioners’ vacation

home.   Like any other residence, Granot Loma was used by

petitioners for their own enjoyment and to entertain family,

friends, and business acquaintances.   Occasional entertainment of

petitioner’s business acquaintances, however, does not support a
                              - 33 -

conclusion that Granot Loma was used in an activity engaged in

for profit.

     While it is certainly true that LFI maintained books and

records of its activities, the record is devoid of any credible

evidence that the books and records were used to make informed

business decisions regarding the operation of a business at

Granot Loma.   See Golanty v. Commissioner, 72 T.C. 411, 430

(1979) (holding that a taxpayer’s books and records should enable

the taxpayer to cut expenses, increase profits, and evaluate the

overall performance of the operation), affd. without published

opinion 647 F.2d 170 (9th Cir. 1981).   LFI did not engage in any

market studies or meaningful research regarding the likelihood of

operating Granot Loma as a commercial lodge for profit.   It did

not set the per capita charges billed to petitioner’s other

companies by analyzing what was necessary to turn a profit or

even by analyzing LFI’s total operating costs.   As best we can

ascertain from the record, LFI made no meaningful effort to

evaluate the cost efficiency of capital expenditures or to cut

the costs of “operating” the lodge.

     Neither petitioner nor any of his principal advisers had any

material experience operating a hotel, motel, or other

commercially viable lodging establishment.   Some of petitioner’s

equipment and system suppliers had commercial experience but only

insofar as the design and use of such equipment and systems were
                               - 34 -

concerned.   The only person with resort management experience

whom petitioner apparently consulted visited Granot Loma once and

merely opined that the property might be used as a resort

property without any apparent analysis of the pertinent financial

data and without the benefit of any market study into the

feasibility of operating such a resort profitably.

     Petitioner has conceded that Granot Loma was never operated

as a commercial resort and that only invited guests stayed there

during the years at issue.   In testimony at trial, that

concession was explained, at least in part, by the admission that

petitioners did not want to open Granot Loma to uninvited guests

because it would interfere with their use of the property.    The

evidence also suggests that, during the years at issue, LFI did

not have the licenses and permits to operate a commercial

facility required under Michigan State law, that Granot Loma was

not insured for business use, and that LFI did not file State

liquor tax returns or collect sales tax on its purported gross

receipts.    Although petitioner vociferously proclaimed throughout

the trial that LFI operated Granot Loma for profit and was a real

business, LFI did not take even the most minimal of steps under

Michigan State law to make its alleged rental activity function

like a real business.

     Petitioner argues that LFI made changes in its operation of

Granot Loma to foster profitability.    The principal change he
                              - 35 -

cites was the annual increase in the per capita rate charged for

a visit to Granot Loma.   While it is true that LFI increased the

per capita rate on an annual basis from 1990 through 1992, the

increases were not supported by any meaningful economic analysis,

and the rate increases did not have a material impact on LFI’s

profitability.

     Petitioner also argues that, when he purchased Granot Loma,

he intended to earn a profit from the property, at least in part,

by renovating and selling it as a commercial property.

Petitioners paid $4,380,000 for the property, invested

approximately $2,500,000 more in renovation costs, and expended

millions more in operating costs from 1987 through 1992.

Petitioner has not convinced us that he purchased Granot Loma

with any intention of selling it at a profit (as opposed to using

it as a residence), or that he seriously believed that any

appreciation in the fair market value of Granot Loma would be

sufficient to offset the cumulative losses and generate a profit.

     Petitioner correctly points out that his and LFI’s intention

to make a profit from Granot Loma need not be reasonable, and he

argues that the considerable time he spent working on LFI’s

alleged business activities provides objective support for his

subjective statement of intent.   We reject this argument because,

like much of the evidence petitioner cites in support of his

arguments, the evidence of time spent by petitioner on LFI’s
                              - 36 -

alleged business activities is inadequate, ambiguous, and

unconvincing.   For example, although petitioner and his family

made several visits to Granot Loma during the renovation period,

petitioner kept no log or other records of the actual time he

spent on the renovation effort.   Moreover, even if we were

willing to accept petitioner’s undocumented claims of time spent

on the renovation effort, petitioner’s involvement with and

“supervision” of the renovation was completely consistent with

the desire of any homeowner to make informed decisions regarding

the nature and manner of the work to be done and to monitor the

renovation on his home.   The ambiguous nature of petitioner’s

testimony renders petitioner’s testimony unconvincing and not

credible.

     Respondent presented a much more compelling picture of the

“reality” of Granot Loma.   In addition to the regular use of

Granot Loma by petitioner and his family, friends, and business

acquaintances, respondent introduced evidence showing the

following:

     (1) Petitioner’s accountant “conservatively” concluded that

the vast majority of visits paid for by petitioner’s companies

were for petitioners’ personal use of Granot Loma;

     (2) during the years at issue, petitioner was a man of

considerable financial means who earned millions of dollar each
                               - 37 -

year from his bond trading activities and who offset his earned

income with over $3,300,000 of LFI’s losses;

     (3) petitioner insured Granot Loma as a second residence and

certain personal property at Granot Loma as his personal, and

insurable, property;

     (4) LFI did not generate a profit from its alleged operation

of Granot Loma during any year at issue;

     (5) petitioners never transferred Granot Loma’s legal title

to LFI; and

     (6) petitioner and his family, friends, and business

acquaintances derived considerable personal pleasure from their

use of Granot Loma.

     On balance, we conclude that petitioner has failed to prove

by a preponderance of evidence that LFI was engaged in the

conduct of a trade or business under section 162 or that any

activity allegedly conducted by LFI at Granot Loma was an

activity for profit.17   Consequently, we sustain respondent’s

determination that LFI was not engaged in an activity for profit.

     B.   Respondent’s Determinations With Respect to LFI for
          1989 and 1990

     Section 183 disallows all expenses attributable to an

activity not engaged in for profit except as provided in section

183(b).   Section 183(b)(1) allows those deductions which are not

     17
      Even if we were to reach petitioner’s section 212
argument, we would still conclude on this record that LFI was not
engaged in an activity for profit.
                              - 38 -

dependent upon a profit motive, such as interest and taxes.

Section 183(b)(2) allows the deductions that would be allowable

only if the activity was engaged in for profit, but only to the

extent that gross income derived from the activity exceeds the

deductions permitted by section 183(b)(1).

     For 1989 and 1990, respondent disallowed all of LFI’s

deductions, determined LFI’s corrected S corporation income, and

adjusted petitioner’s income accordingly.    In so doing,

respondent does not appear to have allowed petitioner any

adjustment for allowable deductions under section 183(b) except

with respect to Granot Loma’s real estate taxes.18   This approach

appears to be inconsistent with the approach taken by respondent

for 1991 and 1992, which effectively allowed petitioner to deduct

LFI’s expenses to the extent of LFI’s income.19

     Respondent takes the position that LFI did not own Granot

Loma and, consequently, may not deduct depreciation attributable

to the property.   Respondent also contends that LFI’s other

expenses were not substantiated, that personal and capital

expenditures are not deductible, and that petitioner “failed to

allocate and prove which deductions, if any, are not for personal

     18
      For each of the years at issue, respondent increased
petitioner’s real estate tax deduction on Schedule A of
petitioner’s Federal income tax returns for the real estate taxes
attributable to Granot Loma, presumably because he determined
petitioner owned Granot Loma.
     19
      Respondent also disallowed petitioner’s deduction of LFI’s
loss for 1988. However, LFI did not report any income for 1988.
                               - 39 -

expenditures”.    Respondent, nevertheless, allows petitioner to

offset LFI’s income with LFI’s expenses for 1991 and 1992, but

not for 1989 or 1990.

     Petitioner contends that, although legal title to Granot

Loma was never transferred to LFI, LFI owned a beneficial and

depreciable interest in the property and that LFI should be

allowed to deduct depreciation to the extent provided in section

183(b)(2).    Petitioner relies on several cases for the

proposition that command over property or enjoyment of its

economic benefits marks the real owner for Federal tax purposes.

See Speca v. Commissioner, 630 F.2d 554, 557 (7th Cir. 1980)

(quoting Anderson v. Commissioner, 164 F.2d 870, 873 (7th Cir.

1947)), affg. T.C. Memo. 1979-120; Hang v. Commissioner, 95 T.C.

74, 80 (1990).    Petitioner, however, has failed to convince us

that LFI owned any beneficial interest in Granot Loma.     The

record instead persuasively establishes that petitioners

personally controlled, used, and enjoyed Granot Loma throughout

the years at issue.

     Regarding LFI’s other deductions, petitioner did not address

respondent’s argument that those deductions were unsubstantiated.

Ordinarily, a taxpayer is required to substantiate claimed

deductions.    See sec. 1.6001-1(a), Income Tax Regs.   In this

case, the parties did not stipulate that LFI incurred any

expenses and because petitioners introduced no evidence at trial

to prove the nature and amount of LFI’s expenses, we would
                               - 40 -

ordinarily hold that petitioner has failed to prove that LFI paid

or incurred any expenses in excess of those allowed by

respondent.    In this case, however, because the notices of

deficiency take what appear to us to be inconsistent positions

with respect to LFI’s expenses20 and, in our view, appear to

acknowledge petitioner’s entitlement to a deduction for a portion

of LFI’s expenses under section 183(b) for 1991 and 1992, we

shall require respondent to make adjustments for 1989 and 1990

under section 183(b) comparable to those made for 1991 and 1992.

      C.   The Parties’ Other Arguments

      We decline to address the parties’ other arguments regarding

LFI as our holdings under sections 162 and 183 adequately dispose

of the LFI issues raised by the parties.

II.   BAC Issues

      In the notices of deficiency, respondent recalculated BAC’s

taxable income by disallowing all of BAC’s expenses and making

certain adjustments to income, increased petitioner’s income by

his distributable share of BAC’s corrected S corporation income,

and allowed petitioner additional miscellaneous Schedule A

deductions to the extent of petitioner’s distributable share of

BAC’s income for each of the years at issue.



      20
      For example, the notices of deficiency allege generally
that LFI’s losses and/or expenses were not substantiated but
allow petitioner an adjustment under sec. 183(b) for some of the
years at issue.
                              - 41 -

     In an amendment to petition filed pursuant to a motion for

leave to amend petition that we granted, petitioner alleged that

he was not entitled to BAC’s passthrough losses, reasoning that

BAC did not have a valid S corporation election on file at any

time during the relevant taxable years, and asserted that we

lacked jurisdiction over respondent’s BAC adjustments because

respondent never issued a notice of deficiency to BAC as a C

corporation.   Respondent filed a notice of objection raising the

affirmative defenses of equitable estoppel and the duty of

consistency and an amendment to answer that clarified that he had

not placed the status of BAC as an electing corporation under

subchapter S at issue in the consolidated cases.

     Section 1362(a) provides that small business corporations

may elect to be governed by the provisions of subchapter S and to

be taxed thereunder as passthrough entities.    For such an

election to be valid, all shareholders of the corporation, as of

the date the election is made, are required to consent to the

election.   Sec. 1362(a)(2); Wilson v. Commissioner, 560 F.2d 687,

689 (5th Cir. 1977), affg. T.C. Memo. 1975-92.    The parties agree

that Mrs. Baldwin did not sign the Form 2553.    The parties do not

agree, however, as to whether respondent may continue to treat

BAC as an S corporation for the years at issue.    We examine the

duty of consistency to resolve the dispute.
                                 - 42 -

     A.    The Duty of Consistency

     The duty of consistency, sometimes referred to as quasi-

estoppel, is an equitable doctrine that Federal courts

historically have applied in appropriate cases to prevent unfair

tax gamesmanship.      Kielmar v. Commissioner, 884 F.2d 959, 965

(7th Cir. 1989), affg. Glass v. Commissioner, 87 T.C. 1087

(1986); Cluck v. Commissioner, 105 T.C. 324 (1995); LeFever v.

Commissioner, 103 T.C. 525 (1994), affd. 100 F.3d 778 (10th Cir.

1996).    The duty of consistency doctrine “is based on the theory

that the taxpayer owes the Commissioner the duty to be consistent

in the tax treatment of items and will not be permitted to

benefit from the taxpayer’s own prior error or omission.”        Cluck

v. Commissioner, supra at 331.     It prevents a taxpayer from

taking one position on one tax return and a contrary position on

a subsequent return after the limitations period has run for the

earlier year, if such contrary position would harm the

Commissioner.    Id.

     This case is appealable to the Court of Appeals for the

Seventh Circuit.    In Kielmar v. Commissioner, supra at 965, the

Court of Appeals for the Seventh Circuit held that a taxpayer is

placed under a duty of consistency when there has been:     (1) A

representation or report by the taxpayer; (2) on which the

Commission has relied; and (3) an attempt by the taxpayer after

the period of limitations has run to change the previous

representation or to recharacterize the situation in such a way
                               - 43 -

as to harm the Commissioner.       Because the duty of consistency is

an affirmative defense, respondent bears the burden of proving

that it applies.    Rule 142(a).

       From 1988 until approximately 1 month before trial,

petitioner consistently represented to respondent that BAC was an

S corporation.    Petitioner initially caused Form 2553, Election

by a Small Business Corporation, which indicated that Mrs.

Baldwin was BAC’s sole shareholder and that she had the authority

to elect S corporation status for BAC, to be filed on behalf of

BAC.    Petitioner also caused BAC to file Forms 1120S, U.S. Income

Tax Return for an S Corporation, and deducted BAC’s passthrough

losses on his Forms 1040, U.S. Individual Income Tax Return, for

the years at issue.    Petitioner did not inform respondent during

the audit that the validity of BAC’s S corporation election was

an issue.    Petitioner also represented, under oath, in formal

discovery proceedings in this case that BAC was an S corporation.

Petitioner now seeks to repudiate BAC’s S corporation status, in

an effort to deprive this Court of jurisdiction over the BAC

issues and respondent of the opportunity to obtain a ruling on

the BAC issues raised in this case.

       Petitioner argues that the duty of consistency does not

apply because respondent has failed to prove that respondent

reasonably relied upon BAC’s S election when issuing the notices
                                - 44 -

of deficiency or that respondent suffered any harm as a result of

his reliance.   Petitioner also contends that the duty of

consistency does not apply because petitioner did not

intentionally misrepresent BAC’s S status or even know that BAC’s

S election was improper.

     Petitioner’s argument that respondent could not have

reasonably relied upon BAC’s S corporation election when issuing

the notices of deficiency, because respondent knew or had reason

to know the S election was invalid, is based on the testimony of

his accountant, Mr. DiMaggio.    Mr. DiMaggio testified that the

auditing agent, Ms. Witek, became aware of a problem with BAC’s S

corporation election by watching petitioners’ divorce proceeding

in 1991.

     Taking Mr. DiMaggio’s testimony in context, it appears that

the problem Mr. DiMaggio described in his testimony involved a

dispute between petitioners regarding the ownership of BAC, not

the validity of its S election.    Even if we were to believe Mr.

DiMaggio’s testimony that Ms. Witek somehow became aware of a

dispute between petitioners regarding the ownership of BAC, we

disagree with petitioner’s conclusion that such knowledge put

respondent on notice regarding a problem with BAC’s S election.

Although petitioners raised an issue regarding which one of them

owned BAC during the pendency of the divorce case, neither

petitioner raised or acknowledged any issue concerning the
                               - 45 -

validity of the S election or conceded that the S election was

invalid until approximately 1 month before trial.21   In fact,

petitioner continued to claim that BAC was an S corporation and

to deduct BAC’s losses on his tax returns in 1991 and later

years.22   Because the record contains no credible evidence that

respondent knew or had reason to know that BAC’s S election was

invalid until approximately 1 month before the trial in this

case, we reject petitioner’s reliance argument.

     We also reject petitioner’s argument that respondent has not

shown he suffered any harm as a result of petitioner’s

representation.   Petitioner contends that even as a C

corporation, BAC would have no taxable income because BAC’s

deductions exceeded its income for the years at issue.

Petitioner’s argument ignores the fact that respondent disallowed

all of BAC’s deductions, vigorously litigating in a 2-week trial,

among other issues, whether BAC’s activities were engaged in for

profit, whether BAC’s deductions were ordinary and necessary



     21
      Under sec. 1362, once a valid S election has been made,
ownership of an S corporation may change without adversely
affecting the S election because new owners were not required to
consent to the prior S election. See sec. 1.1362-6(a)(2)(i),
Income Tax Regs.
     22
      We also note that Mr. DiMaggio’s testimony conflicted with
the objective facts in the record concerning petitioner’s divorce
case. Mr. DiMaggio testified that Ms. Witek learned about a
problem with BAC in 1991 while observing the divorce trial, yet
the trial in the divorce case did not occur until 1993.
                               - 46 -

business expenses, whether BAC’s deductions were substantiated,

and whether the claimed losses were passive losses under section

469.    If we were to accept petitioner’s concession and refuse to

apply the duty of consistency, respondent would be deprived of

the opportunity to evaluate BAC’s correct tax status or to

determine the proper tax effect of BAC’s activities for the years

at issue.    This is so, at least in part, because, if BAC were a C

corporation as petitioner contends, the limitations period for

assessing income tax deficiencies at the corporate level would

have expired.    The record reveals that respondent relied on

petitioner’s representations regarding BAC’s S status to his

detriment, and we so find.

       Finally, we reject petitioner’s argument that, because he

was not aware of any problem with BAC’s S corporation election

prior to 1998, he did not have personal knowledge of BAC’s failed

S corporation election until after the audit was completed and

the period of limitations had run for the years at issue.

Although petitioner’s argument implies to the contrary, personal

knowledge is not an element of the duty of consistency.     Kielmar

v. Commissioner, 884 F.2d 959 (7th Cir. 1989).    The duty of

consistency may apply to a taxpayer who innocently misrepresents

a fact in a time-barred year and to one who misleads

intentionally.    Beltzer v. United States, 495 F.2d 211, 212 (8th

Cir. 1974); Unvert v. Commissioner, 72 T.C. 807, 816 (1979),

affd. 656 F.2d 483 (9th Cir. 1981).
                               - 47 -

     Respondent has demonstrated that each of the elements of the

duty of consistency identified in Kielmar v. Commissioner, supra,

exists in this case.    First, petitioner consistently represented

BAC as an S corporation for Federal income tax purposes by filing

Forms 2553 and 1120S and by treating it as a passthrough entity

for tax purposes.   Second, respondent has relied upon these

representations to his detriment by auditing BAC as an S

corporation, making adjustments thereto, and adjusting the income

of BAC’s sole shareholder as if he were a shareholder in an S

corporation.   Third, petitioner has altered his previous

representation that BAC was a valid S corporation during each of

the years at issue in favor of the diametrically opposite

representation that BAC was never a valid S corporation.    This

alteration occurred after the period of limitations on assessment

with respect to BAC’s returns, if BAC were a C corporation, had

expired.   See sec. 6501.

     On these facts, we hold that the duty of consistency applies

and that, therefore, petitioner is estopped from claiming that

BAC was not a valid S corporation for the years at issue.

     B.    BAC Losses

     Because BAC is treated as an S corporation for purposes of

this case, we must next address the substance of the parties’

arguments with respect to BAC.    Respondent contends that BAC did

not conduct a trade or business under section 162 or an activity
                                - 48 -

engaged in for profit under section 183 and that, therefore, he

properly disallowed BAC’s expenses and recomputed BAC’s income.

Petitioner asserts that BAC was operated as a trade or business

and that its profit motive is demonstrated by a variety of

factors, including BAC’s effect on the increased profitability of

petitioner’s related businesses.

          1.      Activity Not Engaged in for Profit

     We have already reviewed the relevant law governing our

analysis under sections 162 and 183 in connection with our

holding regarding petitioner’s deductions of LFI’s losses.    We

shall not repeat that discussion here.    We turn, instead, to our

analysis of whether BAC was a trade or business under section 162

or an activity not engaged in for profit under section 183.

     In support of his argument that BAC engaged in its air

transportation activity for profit, petitioner contends that BAC

maintained adequate business records, periodically consulted with

and relied upon experts to operate the activity and to improve

its finances, and regularly increased the per-person fees charged

to its customers to improve its cashflow.    Respondent contends

that BAC was nothing more than a convenient and tax-favorable way

for petitioner and his family, friends, and business

acquaintances to travel to and from Granot Loma and other

vacation sites.    Respondent relies primarily upon BAC’s history

of substantial losses in each of the years at issue, petitioner’s
                               - 49 -

financial status and income during the years at issue, BAC’s and

petitioner’s failure to follow the advice of BAC’s president

regarding steps that should be taken to make BAC a profitable

venture, and the substantial personal use of BAC’s aircraft by

petitioner and his invited guests.

     Our review of the record in this case confirms that BAC was

not an activity engaged in for profit but rather was an activity

established, structured, and operated primarily for the personal

use and benefit of petitioner.   We reach this conclusion by

applying the factors set forth in section 1.183-2(b), Income Tax

Regs., to the extent pertinent to our analysis, to the relevant

facts established by the record.

     After petitioners purchased Granot Loma in 1987, petitioner

decided to purchase the first of two aircraft.   On May 20, 1988,

petitioner purchased a King Air and formed BAC to own and operate

the aircraft.   In August 1988, BAC traded in the King Air for the

Sabre.   Petitioner regularly used BAC’s Sabre to transport

himself and his family, friends, and business acquaintances to

Granot Loma.    In an effort to structure the operation and use of

the Sabre as a business, petitioner arranged for BAC to invoice

one of his other companies each time the Sabre was used.   At no

point during any of the years at issue did BAC offer the Sabre

for charter by third parties or take the steps necessary to

position the Sabre for use in a charter or leasing business.
                              - 50 -

Nevertheless, in 1993, petitioner’s accountant represented to

respondent that BAC operated as a charter service, and BAC made

similar representations concerning the nature of its business on

its tax returns.

     Although BAC maintained extensive accounting records as well

as separate books of account and a separate checking account, BAC

did not consistently generate invoices to petitioner’s other

companies until May 1989.   After November 1990, BAC did not

include passenger names other than petitioner’s in the aircraft

utilization reports and trip recaps maintained by BAC.   BAC did

not maintain any records regarding the nature of the trips taken

on its aircraft; BAC simply contends that each trip was a

business trip because BAC charged a fee for everyone who used its

aircraft.

     The record contains no credible evidence indicating that BAC

ever developed a business plan or that it engaged in any market

analysis before setting its per-passenger rates.   Although BAC

increased its per-passenger rates three times during the years at

issue, the rate increases were implemented without any market

studies in an effort “to successfully withstand any level of IRS

scrutiny”.   BAC did not take any additional steps to increase its

income or reduce its expenses despite advice from both

petitioner’s accountant and David Stubbs, BAC’s pilot and
                              - 51 -

president, in June and July 1989 that BAC’s continued losses

could have potentially “disastrous adverse tax effects.”23

     The record in this case amply demonstrates that petitioner’s

use of BAC’s aircraft was primarily for personal purposes.   That

fact, combined with BAC’s history of substantial losses which

petitioner used to offset his considerable income from trading

during the years at issue, leads us to the conclusion that BAC

did not engage in its air transportation activity with the intent

of making a profit.

          2.   Relationship Between BAC’s Activity and
               Petitioner’s Related Businesses

     Petitioner asserts that BAC’s profit motive is demonstrated

by the Sabre’s effect on the increased profitability of

petitioner’s related businesses.   Petitioner cites Campbell v.

Commissioner, 868 F.2d 833 (6th Cir. 1989), affg. in part and


     23
      In a memorandum dated July 7, 1989, to petitioner, Mr.
Stubbs outlined three options for turning BAC into a profit
center. The three options consisted of the manipulation of
company chargeback rates to ensure that BAC was profitable, the
operation of BAC as a charter service, and the implementation of
a timesharing plan with respect to the Sabre. BAC did not
implement any of the proposals. In another memorandum dated
Apr. 20, 1990, Mr. Stubbs expressed continuing concern over BAC’s
reliance on loans from petitioner and BCC to cover BAC’s expenses
and recommended a large increase in the rates charged to
petitioner’s other companies. Mr. Stubbs noted, however, that
FAA restrictions on passenger fees would force BAC to charge
lower fees to outsiders. In response, BAC increased its
intercompany charges from $1,200 per flight hour in 1989 to
$2,100 per flight hour in 1990 and to $2,500 per flight hour in
1991. These rate increases did not eliminate BAC’s losses.
BAC’s losses in 1988 ($195,610), 1989 ($451,102), 1990
($528,914), 1991 ($381,561), and 1992 ($285,848) exceeded $1.8
million in the aggregate.
                               - 52 -

revg. in part T.C. Memo. 1986-569, for the proposition that the

“entire economic relationship” of related companies must be

analyzed when making a determination regarding profit motivation.

Petitioner also relies upon several cases holding that the

taxpayer had a bona fide profit motive in what he contends are

similar situations.   See, e.g., Cornfeld v. Commissioner, 797

F.2d 1049 (D.C. Cir. 1986); Horner v. Commissioner, 35 T.C. 231

(1960); Kuhn v. Commissioner, T.C. Memo. 1992-460; Lee v.

Commissioner, T.C. Memo. 1986-294; Louismet v. Commissioner, T.C.

Memo. 1982-294.

     The cases cited by petitioner are readily distinguishable

because none of the cases involved an alleged business activity

conducted primarily for the personal benefit of the owner.    For

example, in Campbell v. Commissioner, supra, the Court of Appeals

for the Sixth Circuit held that a taxpayer could deduct losses

from a partnership where the partnership’s only business purpose

was to lease an airplane to a corporation controlled by the

partners of the partnership.   The corporation’s employees and

officers engaged in extensive air travel in furtherance of the

corporation’s business and used the partnership’s airplane to

facilitate that travel.   Despite repeated losses in the

partnership, the Court of Appeals found a profit motive by

considering the overall increase in wealth of the partners

through the corporation, accomplished through the use of
                              - 53 -

transportation and communication efficiencies provided by the

partnership airplane.   In addition, the Court of Appeals found

that losses were due, in large part, to the dramatic rise in the

cost of fuel, inflation, and increased interest rates occurring

during the late 1970s and early 1980s.   The Court of Appeals

concluded that profits generated by the corporation through the

use of the partnership’s plane justified a conclusion that the

partnership venture was an activity engaged in for profit.

     In contrast to the taxpayer in Campbell, petitioner has not

proven even an incidental benefit to his commodities trading

business or any other business resulting from BAC’s activities.

Petitioner testified that his unparalleled trading success was

due to his relationships with other traders and brokers in the

pit and that his discussions with traders and brokers on the

plane trips to and from Granot Loma enabled him to build close

personal relationships with the brokers and traders.   However,

the objective facts in the record demonstrate that after

petitioner purchased the King Air and organized BAC in 1988,

petitioner’s income from his commodities trading business

steadily decreased.

     Also unlike the situation in Campbell, where the plane

leasing partnership was conducted solely to benefit another

business and was wholly dependent upon that business, BAC was

conducted almost exclusively to benefit petitioner personally.    A
                               - 54 -

corporation that is operated for the pleasure or recreation of

its shareholders is not engaged in a trade or business.    Intl.

Trading Co. v. Commissioner, 275 F.2d 578, 584 (7th Cir. 1960),

affg. T.C. Memo. 1958-104.

     The extensive personal use of BAC’s aircraft by petitioner

and his family, friends, and business acquaintances, coupled with

petitioner’s failure to prove a legitimate economic connection

between his successful commodity trading business and BAC,

convinces us that BAC’s air transportation activity was not an

activity engaged in for profit.

          3.     Conclusion

     After considering the factors listed in section 1.183-2(b),

Income Tax Regs., we hold that BAC was not engaged in an activity

for profit.    We decline to address respondent’s other arguments

with respect to the BAC adjustments because our conclusion under

section 183 adequately disposes of respondent’s adjustments with

respect to BAC.24




     24
      Pursuant to sec. 183(b), respondent has allowed petitioner
additional miscellaneous itemized deductions for BAC’s expenses
in amounts equal to BAC’s corrected S corporation income in each
of the years in dispute (before application of the 2-percent
adjusted gross income limitation of sec. 67). Consequently, we
do not separately address the parties’ arguments regarding the
calculation of BAC’s depreciation deduction under sec. 280F or
the ownership of the Cessna that was depreciated by BAC.
                                 - 55 -

III. BCC Issues

      Respondent disallowed lodging and travel deductions in the

amounts of $9,658, $59,174, and $50,651 that BCC claimed on its

1990, 1991, and 1992 returns, respectively.      Respondent alleged

that the deductions were not allowed because they did not meet

the requirements of sections 162 and 274.

      Petitioner did not address the BCC adjustments in either his

opening brief or his reply brief.      Consequently, we deem

petitioner to have conceded the adjustments to BCC’s lodging and

travel deductions.      See Petzoldt v. Commissioner, 92 T.C. 661,

683 (1989); Money v. Commissioner, 89 T.C. 46, 48 (1987).

IV.     Penalties and Additions to Tax

      A.      Sec. 6661(a) Addition to Tax

      For 1988, respondent determined petitioners are liable for

the substantial understatement addition to tax under section

6661.      Section 6661(a) imposes an addition to tax in an amount

equal to 25 percent of any underpayment attributable to such

substantial understatement.      A substantial understatement exists

when the amount of tax required to be shown on a taxpayer’s

return exceeds the amount shown on the return by the greater of

$5,000 or 10 percent of the amount of tax required to be shown on

the return.      Sec. 6661; Schirmer v. Commissioner, 89 T.C. 277,

282 (1987).
                               - 56 -

     An understatement for purposes of section 6661 does not

include any item for which the taxpayer’s return position was

supported by substantial authority.     Sec. 1.6661-3(a)(1), Income

Tax Regs.    Substantial authority exists when the weight of

authorities supporting the treatment is substantial in comparison

to the weight of authorities supporting contrary positions.        Sec.

1.6661-3(b)(1), Income Tax Regs.    A position that is arguable but

fairly unlikely to prevail in court will not be considered as

supported by substantial authority.     Id.   A case having some

facts in common with the tax treatment at issue does not

constitute authority if the case is materially distinguishable on

its facts.    Sec. 1.6661-3(b)(3), Income Tax Regs.

     Petitioner does not rely on any cases which, individually or

collectively, qualify as substantial authority for his reporting

position either with respect to the LFI adjustments or the BAC

adjustments.    Petitioner cites Campbell v. Commissioner, 868 F.2d

833 (6th Cir. 1989), revg. T.C. Memo. 1986-569, for the

proposition that the “entire economic relationship” of related

companies must be analyzed when making a determination regarding

profit motivation.    Petitioner also relies on several cases

holding that the taxpayer had a bona fide profit motive in what

he contends are similar situations.     See, e.g., Cornfeld v.

Commissioner, 797 F.2d 1049 (D.C. Cir. 1986); Horner v.

Commissioner, 35 T.C. 231 (1960); Kuhn v. Commissioner, T.C.
                              - 57 -

Memo. 1992-460; Lee v. Commissioner, T.C. Memo. 1986-294;

Louismet v. Commissioner, T.C. Memo. 1982-294.    We agree with

respondent that the cases are not substantial authority in favor

of petitioner’s position because they are all readily

distinguishable.   Sec. 1.6661-3(b)(3), Income Tax Regs.

     Section 6661(c) authorizes respondent to waive part or all

of this addition to tax upon a showing by the taxpayer that he

had reasonable cause for the understatement and that he acted in

good faith.   Respondent’s failure to waive the addition to tax

under section 6661 is subject to review only for abuse of

discretion.   Mailman v. Commissioner, 91 T.C. 1079, 1082-1084

(1988); Parsons v. Commissioner, T.C. Memo. 2000-205.

     Petitioner did not show that he ever requested a waiver

under section 6661(c) or that respondent ruled on such a waiver.

Even if petitioner had requested a waiver under section 6661(c),

as he seems to suggest, petitioner has not proven he is entitled

to relief under section 6661(c).

     We hold that petitioner is liable for the addition to tax

under section 6661 for 1988 if the Rule 155 computation shows a

substantial understatement of income tax.

     B.   Sec. 6653(a) Addition to Tax for Negligence and Sec.
          6662(a) Accuracy-Related Penalty

     For 1988, respondent also determined that petitioner is

liable for an addition to tax for negligence or intentional

disregard under section 6653(a)(1).    For 1989, respondent
                             - 58 -

determined that petitioner is liable for the accuracy-related

penalty under section 6662(a), alleging that all of the

underpayment for 1989 “is due to negligence or disregard of rules

or regulations and you have not established that such

underpayment of tax was due to reasonable cause.”   For each of

the years 1990 through 1992, respondent determined that

petitioner is liable for the accuracy-related penalty under

section 6662(a), alleging that all or part of petitioner’s

underpayment of tax for each of the years at issue “is

attributable to one or more of (1) negligence or disregard of

rules or regulations, (2) any substantial understatement of

income tax, or (3) any substantial valuation overstatement”.

     As in effect for 1988, section 6653(a)(1) provides that, if

any part of an underpayment of tax is due to negligence or

disregard of rules or regulations, an amount equal to 5 percent

of the underpayment shall be added to the tax.   For purposes of

section 6653(a), negligence is defined as a “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), and includes “any failure to make a reasonable

attempt to comply with the provisions” of the Internal Revenue

Code (the Code), section 6653(a)(3).

     As in effect for 1989, 1990, 1991, and 1992, section 6662(a)

imposes a 20-percent accuracy-related penalty on the portion of
                              - 59 -

an underpayment that, as pertinent here, is due to negligence or

intentional disregard of rules or regulations, section

6662(b)(1), a substantial understatement of income tax, section

6662(b)(2), or a substantial valuation misstatement, section

6662(b)(3).25

     An underpayment is not attributable to negligence or

intentional disregard, substantial understatement of income tax,

or a valuation misstatement under section 6662 to the extent that

the taxpayer shows that he had reasonable cause for the

underpayment and that he acted in good faith with respect to such

underpayment.   Sec. 6664(c); secs. 1.6662-3(a), 1.6664-4(a),

Income Tax Regs.   To prove he had reasonable cause for an

underpayment, a taxpayer must show that he exercised ordinary

business care and prudence with respect to the disputed item.

United States v. Boyle, 469 U.S. 241 (1985); see also Neonatology

Associates, P.A. v. Commissioner, 115 T.C. 43, 98 (2000).    In

this case, petitioner bears the burden of proving that he is not

liable for the addition to tax under section 6653(a) and the



     25
      For purposes of sec. 6662(b)(1), negligence is defined to
include “any failure to make a reasonable attempt to comply with
the provisions of [the Code]”, and disregard is defined to
include “any careless, reckless, or intentional disregard.” Sec.
6662(c). For purposes of sec. 6662(b)(2), there is a substantial
understatement of income tax for any taxable year if the amount
of the understatement exceeds the greater of 10 percent of the
tax required to be shown on that year’s tax return or $5,000.
Sec. 6662(d)(1)(A). For purposes of sec. 6662(b)(3), a valuation
misstatement is as defined in sec. 6662(e).
                                - 60 -

penalties under section 6662.    Rule 142(a); Richardson v.

Commissioner, 125 F.3d 551 (7th Cir. 1997), affg. T.C. Memo.

1995-554; Accardo v. Commissioner, 942 F.2d 444, 453 (7th Cir.

1991), affg. 94 T.C. 96 (1990).

     A taxpayer’s good faith, reasonable reliance on the advice

of an independent professional as to the tax treatment of an item

may establish that the taxpayer was not negligent under section

6653(a) and may satisfy the reasonable cause exception of section

6664(c).    United States v. Boyle, supra; sec. 1.6664-4(b), Income

Tax Regs.   Whether a taxpayer reasonably relied on an independent

and competent professional requires an examination of the facts

and circumstances of his case and applicable law.    See sec.

1.6664-4(b)(1), Income Tax Regs.    The taxpayer must prove: (1)

The adviser was a competent professional who had sufficient

expertise to justify the taxpayer’s reliance on him; (2) the

taxpayer provided necessary and accurate information to the

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

the adviser’s judgment.   Weis v. Commissioner, 94 T.C. 473, 487

(1990) (citing Pessin v. Commissioner, 59 T.C. 473, 489 (1972)).

     In support of his determinations, respondent emphasizes

petitioner’s burden of proof as to the addition to tax and

penalties, lists numerous errors and purported errors on

petitioner’s returns, and asserts that petitioner, with the

assistance of Mr. DiMaggio, concocted an elaborate scheme to

disguise and deduct personal expenditures.   Petitioner contends
                               - 61 -

that his deductions were claimed in good faith and pursuant to

his reasonable reliance upon his professional tax adviser, Mr.

DiMaggio, and his lawyers.

     Although petitioner places the blame for erroneous reporting

positions on both his accountant and his attorney, petitioner

directs most of the blame to his accountant, Mr. DiMaggio.

Petitioner claims, among other things, that it was Mr. DiMaggio

who decided to treat LFI and BAC as businesses under section 162,

who decided that LFI and BAC met the material participation

requirements of section 469, and who decided to treat BAC as an S

corporation for Federal tax purposes.   Petitioner also claims

that he reasonably relied upon his accountant for all decisions

regarding the proper tax treatment of LFI and BAC.

     Mr. DiMaggio testified extensively at the trial in this

case.   Although Mr. DiMaggio admitted that he consulted with

petitioner concerning LFI and BAC, at no point during his

testimony did Mr. DiMaggio admit that he was responsible for the

reporting positions taken on petitioner’s returns with respect to

LFI and BAC.   Mr. DiMaggio’s testimony only reinforces the

impression left by the record as a whole that he did not have

accurate information regarding the use of Granot Loma and the

aircraft and that petitioner intended from the time he purchased

Granot Loma and the aircraft to claim they were business assets

used in a business activity.   For example, although Mr. DiMaggio

never visited Granot Loma during the years at issue, Mr. DiMaggio
                              - 62 -

testified that Granot Loma “operated no differently than a

Marriott or a Radisson”.   Mr. DiMaggio also testified that LFI

was operating as a business during 1988 because “people were

staying up there, overnight stays for business purposes.”    In

justifying the decision to depreciate Granot Loma, Mr. DiMaggio

testified that “the property was placed in service from a

business standpoint the minute Mr. Baldwin purchased it”, a

position petitioner consistently espoused throughout the trial

and briefing of this case.

     Petitioner was obligated to prove that he gave all pertinent

information necessary to decide the proper tax treatment of

Granot Loma and the aircraft to Mr. DiMaggio.   Mr. DiMaggio’s

testimony leaves us with considerable doubt that petitioner gave

Mr. DiMaggio all of the information necessary to determine

whether and to what extent LFI and BAC were actually operating a

trade or business within the meaning of section 162 or whether

the activities conducted by the corporations were not engaged in

for profit within the meaning of section 183.

     Having observed Mr. DiMaggio and petitioner at trial and

heard their testimony, we have no doubt that petitioner was an

important and demanding client of Mr. DiMaggio, that Mr. DiMaggio

wanted to keep petitioner happy, and that Mr. DiMaggio, without

having first received relevant and accurate information, either

concluded or accepted petitioner’s conclusion that LFI and BAC

were legitimate businesses.   Mr. DiMaggio’s apparent willingness
                                - 63 -

to treat LFI and BAC as businesses under section 162 and to

ignore his concerns regarding the possible application of section

183 without a healthy degree of skepticism and some meaningful

professional analysis falls short of proof establishing that

petitioner reasonably relied on the informed and studied advice

of a competent tax professional.

      We also have considerable doubt whether petitioner acted in

good faith when he signed his tax returns for the years at issue.

Petitioner, an experienced businessman, knew or certainly should

have known that he and his family and invited guests used Granot

Loma and BAC’s aircraft primarily for personal relaxation and

entertainment.   Possessed of such knowledge, petitioner cannot

credibly claim that he signed his tax returns in good faith.

Under the circumstances, petitioner’s attempt to avoid liability

for the additions to tax and penalties by claiming he did not

know any better is ludicrous.

     Because petitioner has failed to prove that he was not

negligent under sections 6653(a) and 6662 or that he is entitled

to relief under section 6664(c), we reject petitioner’s arguments

that he should be relieved of the section 6653 addition to tax

and the section 6662 penalties in these consolidated cases.
                             - 64 -

V.   Conclusion

     We have carefully considered the remaining arguments of both

parties for results contrary to those expressed herein and, to

the extent not discussed above, find those arguments to be

irrelevant, moot, or without merit.

     To reflect the foregoing and concessions by both parties,


                                      Decisions will be entered

                              under Rule 155.
